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Extracredit1solutions

# Extracredit1solutions - 3 If beta> 1 then your company is...

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Finance 315 online: Extra Credit 1 solutions: 1a: The market risk premium is 8%-3% = 5%. 1b: Graphically, the slope increases. (See page 256 in our textbook). 1c: False, required rates of return rise. (See page 256) 1d: The new required rate of return is r RF + (rm – r RF )B = 3% + (6%)1.5 = 12%. Since this is greater than the expected return, the company is overvalued. 2. An example would be Outback steakhouse. Mad Cow disease would affect their sales. This is an example of company specific risk. It is diversifiable. An example of market risk is the risk the U.S. goes into a recession. This affects all companies.

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Unformatted text preview: 3. If beta > 1, then your company is riskier than the market. If it is < 1, your company is less risky than the market. 4. True: 5. Choose Bank 1: EFF% bank one = (1 + (0.08/365)) 365 -1 = 0.08328 = 8.328% EFF % bank two = (1+ (0.081/2) 2-1 = 0.08264 = 8.264% 6. Po = D1 / (r s –g) = [1.30 (1.06)] / (.11-.06) = 27.56. where D1 = Do(1+g) Since the intrinsic value of 27.56 is greater than the market price, the stock is undervalued. Expected rs = (D1 / Po) + g = [(1.30x1.06) / 25] + 0.06 = 0.1151 = 11.51%. The expected return is greater than the required return of 11%. So the answer is C....
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