Module03Tutorial - July 2003 FIN2101 BUSINESS FINANCE II...

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July 2003 FIN2101 BUSINESS FINANCE II MODULE 3 - APPLICATION OF CAPM QUESTION 1 The three divisions of Bonza Ltd are engaged in leisure wear, graphics, and household paint. The company has identified listed companies in each of these lines of business. On the basis of analysing the performance of the shares of those companies in relation to the market index, Bonza has estimated that the systematic risk of each of its three divisions is as follows: Division Beta Leisure wear 1.16 Graphics 1.64 Paint 0.70 The expected return on the market index is 13% in the foreseeable future, and the risk-free rate is currently 7%. The divisions are evaluating a number of independent projects which have the following expected returns: Project Division Return 1 Graphics 18% 2 Paint 12% 3 Paint 10% 4 Leisure wear 26% 5 Leisure wear 13% 6 Graphics 21% 7 Paint 14% 8 Graphics 16% Which projects should be accepted and which rejected? QUESTION 2 The risk-free rate is presently 5% and the expected return on the market portfolio is 10%. The expected returns (based on market prices) for four (4) companies' ordinary shares are listed below, together with their expected betas. Company Expected Return (k s ) Beta Stillman Zinc Corp 12.0% 1.3 Union Paint Co 9.5% 0.8 National Auto Co 10.5% 1.1 Parker Electronics Ltd 13.0% 1.7 On the basis of these expectations, which shares are overvalued? Which are undervalued?
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July 2003 QUESTION 3 Sutton Safes Ltd has a debt-to-equity ratio (at market values) of 0.75 (3:4). Its present cost of debt funds is 10% before tax, and its marginal tax rate is 30%. Sutton Safes is considering entry into the automated-teller-machine business, a field that involves electronics and is considerably different from its own, so that the company is looking for a proxy company which might provide it with a relevant discount rate. Peerless Machines Ltd, a listed company, produces only automated-teller equipment. Peerless Machines has a debt-to-equity ratio of 0.25 (1:4), a beta of 1.15, and an effective tax rate of 30%. a)
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This note was uploaded on 12/06/2011 for the course BUSINESS Finance taught by Professor Qilei during the Summer '11 term at Tianjin University.

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Module03Tutorial - July 2003 FIN2101 BUSINESS FINANCE II...

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