E120 Principles of Engineering Economics
Summer 2008
Practice Final
Problem 1
You believe that one month from now
the XYZ Company will pay a dividend of $2 on its
common stock. Thereafter you expect to receive dividends every quarter
. The dividends are
expected to grow at a rate of 1% per quarter in perpetuity. If you require an effective
rate of
return of 12% per year on your investment, how much should you be prepared to pay for the
stock now?
Explain.
Problem 2
In 1999 the risk free interest rate is 5%.
Suppose the expected rate of return required by the
market for a portfolio with a beta of 1 is 12%.
According to the capital asset pricing model:
a)
What’s the expected rate of return on the market portfolio?
b)
What would be the expected rate of return on a stock with
β
=0?
c)
Suppose you consider buying a share of stock at $40.
The stock is expected to pay $3
dividends next year and you expect it to sell then for $41.
The stock risk has been
evaluated at
β
=0.5.
Is the stock overpriced or under priced?
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 Summer '08
 ILAN
 Capital Asset Pricing Model, Expected return Standard

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