1. Holup, Inc., makes pneumatic equipment. The beta of Holup’s stock is 1.2. The expected market risk premium is 8.5 percent, and the current risk-free rate is 6 percent. Assume the capital asset pricing model (CAPM) holds. What is the expected return on Holup’s stock?
2. Suppose the expected market risk premium is 7.5 percent and the risk-free rate is 3.7 percent. The expected return on TriStar’s stock is 14.2 percent. Assume the CAPM holds. What is the beta of TriStar’s stock?
3. How does the relationship between the average return and the historical volatility of individual stocks differ from the relationship between the average return and the historical volatility of large, well-diversified portfolios?
4. Suppose the beta for the Ross Corporation is 0.80. the risk-free rate is 6 percent, and the market risk premium is 8.5 percent. What is the expected return for the Ross Corporation?
5. A stock has a beta of 1.8. A security analyst who specializes in studying this stock expects its return to be 18 percent. Suppose the risk-free rate is 5 percent and the market-risk premium is 8 percent. Is the analyst pessimistic or optimistic about this stock relative to the market's expectations?
6. Lizpaz Inc. is a levered firm with a debt-to-equity ratio of 0.25. The beta of the common stock is 1.15, while the beta of the debt is 0.3. The market-risk premium is 10 percent and the risk-free rate is 6 percent. The corporate tax rate is 35 percent.
a. What is the firm’s cost of equity capital?
b. If a new company project has the same risk as the overall firm, what is the weighted average cost of capital for the project?
7. Lavan Industries, Inc., is considering a new project with a $25 million initial outlay. The project will generate after-tax (year-end) cash flows of $7 million for five years. The firm has a debt-to-equity ratio of 0.75. The cost of equity is 15 percent and the before-tax cost of debt is 9 percent. The corporate tax rate is 35 percent. The project has the same risk as the overall firm. Should Lavan accept the project?
8. Acetate, Inc., has equity with a market value of $20 million and debt with a market value of $10 million. The cost of the debt is 14 percent per annum. Treasury bills that mature in one year yield 8 percent per annum, and the expected return on the market portfolio over the next year is 18 percent. The beta of Acetate’s equity is 0.9. The firm pays no taxes.
a. What is Acetate’s debt-equity ratio?
b. What is the firm’s weighted average cost of capital?