Problem 11-2
Assumptions
Investment
$1,500,000
Expected Cash Flow at Harvest
$3,200,000
Years to Harvest
2
Standard Deviation of Cash Flows
$2,000,000
Correlation with Market
0.2
One-year Variance of Market Returns
4%
Annual Risk-Free Rate
7.0%
Expected Annual Return on Market Portfolio
13.5%
a.
CEQ Form of CAPM - Diversified Investor
Holding Period Standard Deviation of Market
28.3%
Holding Period Risk-Free Rate
14.5%
Holding Period Market Return
28.8%
Holding Period Market Risk Premium
14.3%
Risk Adjustment to Expected Cash Flow
$202,692
Certainty Equivalent Cash Flow
$2,997,308
Present Value
$2,617,965
Net Present Value
$1,117,965
b.
RADR Form of CAPM - Diversified Investor
Equilibrium Standard Deviation of Holding Period Returns
76.4%
Beta
0.54
Holding Period Required Rate of Return
22.2%
Present Value
$2,617,965
Net Present Value
$1,117,965
c.
CEQ Form of CAPM - Full Commitment
Risk Adjustment to Expected Cash Flow
$1,013,461
Certainty Equivalent Cash Flow
$2,186,539
Present Value
$1,909,808
Net Present Value
$409,808
d.
RADR Form of CAPM - Full Commitment
Equilibrium Standard Deviation of Holding Period Returns
104.7%
Holding Period Required Rate of Return
67.6%
Present Value
$1,909,808
Net Present Value
409,808
$