HW_2_Solutions_Chapters_12_13[1]

HW_2_Solutions_Chapters_12_13[1] - Solutions to Chapter 12...

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5-1 Solutions to Chapter 12 Risk, Return, and Capital Budgeting 1. a. False. Investors require higher expected rates of return on investments with high market risk, not high total risk. Variability of returns is a measure of total risk. b. False. If beta = 0, then the asset’s expected return should equal the risk-free rate, not zero. c. False. The portfolio is invested one-third in Treasury bills and two-thirds in the market. Its beta will be: (1/3 × 0) + (2/3 × 1.0) = 2/3 d. True. e. True. 6. a. The expected cash flows from the firm are in the form of a perpetuity. The discount rate is: r f + β (r m – r f ) = 4% + 0.4 × (11% – 4%) = 6.8% Therefore, the value of the firm would be: 82 . 058 , 147 $ 068 . 0 000 , 10 $ r flow Cash P 0 = = = b. If the true beta is actually 0.6, the discount rate should be: r f + β (r m – r f ) = 4% + [0.6 × (11% – 4%)] = 8.2% Therefore, the value of the firm is: 22 . 951 , 121 $ 082 . 0 000 , 10 $ r flow Cash P 0 = = = By underestimating beta, you would overvalue the firm by: $147,058.82 – $121,951.22 = $25,107.60 13. The appropriate discount rate for the project is: r = r f + β (r m – r f ) = 4% + 1.4 × (12% – 4%) = 15.2% Therefore: NPV = –$100 + [$15 × annuity factor(15.2%, 10 years)] = –$100 + $15 29 . 25 $ (1.152) 0.152 1 0.152 1 10 = × ×
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5-2 You should reject the project. 15. From the CAPM, the appropriate discount rate is: r = r f + β (r m – r f ) = 4% + (0.75 × 7%) = 9.25% r = 0.0925 = + = + 50 50) - P ( 2 price gain capital DIV 1 P 1 = $52.625 22. r = r f + β (r m r f ) 5 = r f + 0.5(r m r f ) (stock A) 13 = r f + 1.5(r m r f ) (stock B) Solve these simultaneous equations to find that: r f = 1% and r m = 9% Chapter 13 3. × + × + × × = equity preferred C debt r V E r V P ) T 1 ( r V D WACC = [0.3 × 7.50% × (1 – 0.35)] + [0.2 × 10%] + [0.5 × 12.0%] = 9.46% 5. The total value of the firm is $80 million. The weights for each security class are as follows: Debt: D/V = 20/80 = 0.250 Preferred: P/V = 10/80 = 0.125 Common: E/V = 50/80 = 0.625 × + × + × × = equity preferred C debt r V E r V P ) T 1 ( r V D
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This note was uploaded on 09/06/2011 for the course FIN 351 taught by Professor Li during the Spring '09 term at S.F. State.

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HW_2_Solutions_Chapters_12_13[1] - Solutions to Chapter 12...

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