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Unformatted text preview: Unit 6: 1. Question: Magee Company's stock has a beta of 1.20, the riskfree rate is 4.50%, and the market risk premium is 5.00%. What is Magee's required return? Your Answer: 10.25 % 10.50 % C ORR ECT 10.75 % 11.00 % 11.25 % Instructor Explanation: R Magee = R RF + (R M – R RF ) R Magee = 4.50% + 1.20(5.00%) = 10.50% Points Received: 4 of 4 2. Question: Parr Paper's stock has a beta of 1.40, and its required return is 13.00%. Clover Dairy's stock has a beta of 0.80. If the riskfree rate is 4.00%, what is the required rate of return on Clover's stock? (Hint: First find the market risk premium.) Your Answer: 8.55 % 8.71 % 8.99 % 9.14 % C ORR ECT 9.33 % Instructor Explanation: First, you need to calculate the market risk premium. You can do this using Parr Paper information: R Parr = R RF + (R M – R RF ) 13.00% = 4.00% + 1.40(R M – R RF ) 6.43% = (R M – R RF ) Using this information, we can now calculate the require return for Clover: R Clover = R RF + (R M – R RF ) R Clover = 4.00% + .80(6.43%) = 9.14% Points Received: 4 of 4 3. Question: Suppose you hold a diversified portfolio consisting of $10,000 invested equally in each of 10 different common stocks. The portfolio’s beta is 1.120. Now suppose you decided to sell one of your stocks that has a beta of 1.000 and to use the proceeds to buy a replacement stock with a beta of 1.750. What would the portfolio’s new beta be? Your Answer: 0.98 2 1.01 7 1.19 5 C ORR ECT 1.24 6 1.51 9 Instructor Explanation: We need to calculate the beta of the portfolio’s nine stocks that we are keeping. These nine represent 90% of the total value of the portfolio and 90% of the beta: .9x + .1(1.00) = 1.120 .9x = 1.02 x = 1.1333 If we add one stock with a beta of 1.75, we get: .9(1.1333) + .1(1.75) = 1.02 + .175 = 1.195 Points Received: 4 of 4 4. Question: A mutual fund manager has a $20.0 million portfolio with a beta of 1.50. The riskfree rate is 4.50%, and the market risk premium is 5.50%. The manager expects to receive an additional $5.0 million which she plans to invest in a number of stocks. After investing the additional funds, she wants the fund’s required return to be 13.00%. What must the average beta of the new stocks added to the portfolio be to achieve the desired required rate of return? Your Answer: 1.12 1.26 1.37 1.59 1.73 C ORR ECT Instructor Explanation: First, we need to figure out what the beta of the new portfolio will be: R new = R RF + Beta(R M – R RF ) 13% = 4.50% + Beta(5.50%) 8.50% = Beta(5.50%) 1.5455 = Beta of the NEW $25MM portfolio Now we can calculate the beta of the new stocks (New Beta). We know that the size of the portfolio will now be $25 million and that $20 million has a beta of 1.50: (another weighted average!!!) ($20M / $25M) 1.50 + ($5M / $25M)New Beta = 1.5455 1.20 + .20(New Beta) = 1.5455 .20(New Beta) = .3455 New Beta = 1.7275 or about 1.73 Points Received: 4 of 4 5. Question: A stock is expected to pay a dividend of $1 at the end of the year. The A stock is expected to pay a dividend of $1 at the end of the year....
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 Spring '10
 Denise
 Corporate Finance, Net Present Value, Internal rate of return, Weighted average cost of capital, ORR ECT

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