Fundamentals of Corporate Finance (Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate)
9th Edition
ISBN: 9781259722615
Author: Richard A Brealey, Stewart C Myers, Alan J. Marcus Professor
Publisher: McGraw-Hill Education
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Chapter 11, Problem 5QP
Risk Premiums and Discount Rates. Top hedge fund manager Sally Buffit believes that a stock with the same market risk as the S&P 500 will sell at year-end at a price of $50. The stock will pay a dividend at year-end of $2. What price should she be willing to pay for the stock today? Assume that risk-free Treasury securities currently offer an interest rate of 2%. Use Table 11.1 to find a reasonable discount rate.
TABLE 11.1
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Top hedge fund manager Sally Buffit believes that a stock with the same market risk as the S&P 500 will sell at year-end
at a price of $50. The stock will pay a dividend at year-end of $2. Assume that risk-free Treasury securities currently
offer an interest rate of 2%.
Average rates of return on Treasury bills, government bonds, and common stocks, 1900-2017 (figures in percent per
year) are as follows.
Average Premium
(Extra return
veraus Treasury
bills) ()
Average Annual
Rate of Return
Portfolio
Treasury billa
Treasury bonda
Common atocks
(%)
3.8
5.3
11.5
1.5
7.7
a. What is the discount rate on the stock? (Enter your answer as a percent rounded to 2 decimal places.)
Discount rate
%
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The following graph plots the current security market line (SML) and indicates the return that investors require from holding stock from Happy Corp. (HC). Based on the graph, complete the table that follows.
For graph see image 13a
CAPM Elements
Value
Risk-free rate (rRFRF)
Market risk premium (RPMM)
Happy Corp. stock’s beta
Required rate of return on Happy Corp. stock
An analyst believes that inflation is going to increase by 2.0% over the next year, while the market risk premium will be unchanged. The analyst uses the Capital Asset Pricing Model (CAPM). The following graph plots the current SML.
Calculate Happy Corp.’s new required return. Then, on the graph, use the green points (rectangle symbols) to plot the new SML suggested by this analyst’s prediction.
Happy Corp.’s new required rate of return is _____?.
For grapgh see image 13b
The SML helps determine the level of risk aversion among investors.…
Bond valuation related problems should be solved by using a financial calculator or MS excel spreadsheet. Accordingly, you must show the values of all relevant time valu of money variables
Tasla stock recently paid a dividend of $0.75. The required rate of return is ke or rs = 10.5%, and the expected constant growth rate is g = 6.4%. What is the stock's current price?
Chapter 11 Solutions
Fundamentals of Corporate Finance (Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate)
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- A) What expected return should an investor expect from investments in common stock? You are given the following information: Risk free rate of return = 4%; market risk premium = 11%; Beta of the stock (assume CAPM holds) = 0.72. B) Stock A with beta of 0.8 offers a 11% return while stock B with a beta of 1.2 offers a 15% return. What is the risk-free rate? What is the common market return? Assume CAPM holds.arrow_forwardAs an equity analyst, you have developed the following return forecasts and risk estimates for two different stock mutual funds (Fund T and Fund U): Fund T Fund U Forecasted Return 9.0% 10.0 CAPM Beta 1.20 0.80 a) If the risk-free rate is 3.9 % and the expected market risk premium is 6.1%, calculate the expected return for each mutual fund according to the CAPM. b) Using the estimated expected returns from Part a along with your own return forecasts, explain whether Fund T and Fund U are currently priced to fall directly on the security market line (SML), above the SML, or below the SML. Are Funds T and U overvalued, undervalued, or properly valued?arrow_forwardThe following graph plots the current security market line (SML) and indicates the return that investors require from holding stock from Happy Corp. (HC). Based on the graph, complete the table that follows: REQUIRED RATE OF RETURN (Percent) 20.0 16.0 12.0 1,8 Return on HC's Stock 8.0 4.0 0 0 0.5 1.0 1.5 2.0 RISK (Beta) CAPM Elements Risk-free rate (RF) Market risk premium (RPM) Happy Corp. stock's beta Required rate of return on Happy Corp. stock Value An analyst believes that inflation is going to increase by 3.0% over the next year, while the market risk premium will be unchanged. The analyst uses the Capital Asset Pricing Model (CAPM). The following graph plots the current SML. Calculate Happy Corp.'s new required return. Then, on the graph, use the green points (rectangle symbols) to plot the new SML suggested by this analyst's prediction. Happy Corp.'s new required rate of return isarrow_forward
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