week 2 homework

# week 2 homework - 1 1 Using Formula 71 on page 144 compute...

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1 1. Using Formula 7–1 on page 144, compute RF (risk-free rate). The real rate of return is 3 percent and the expected rate of inflation is 5 percent. Rf=(1+.03)(1+.05)-1 =1.08-1 = 8% 2. If RF = 6 percent, b =1.3, and the ERP = 6.5 percent, compute Ke (the required rate of return). 6%+1.3(6.5%) =6%+8.45=14.45% 3. If in problem 2 the beta ( b ) were 1.9 and the other values remained the same, what is the new value of Ke ? What is the relationship between a higher beta and the required rate of return (Ke )? 6+1.9(6.5%) =6+12.35%=18.35% As beta goes down, so does Ke 4. Assume the same facts as in problem 2, but with an ERP of 9 percent. What is the new value for Ke ? What does this tell you about investors’ feelings toward risk based on the new ERP? Ke=6%+1.3%(9%) =6%+11.7%=17.7% Investors require a higher rate of return when risk is high. Ch 8 2006 2007 Sales \$500,000 \$700,000 Gross Profit 161,300 205,000 45,200 74,300 Interest Expenses 15,200 29,100 Net Income

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week 2 homework - 1 1 Using Formula 71 on page 144 compute...

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