You are a small money manager managing $9,000,000 in assets. Your investment por

Question

You are a small money manager managing $9,000,000 in assets. Your investment portfolio consists of 10% T-bills (with an estimated beta = 0), 15% bonds (with an estimated beta = 0.70), 35% mid-cap stocks (with an estimated beta = 1.00), and 40% growth stocks (with an estimated beta = 1.40).

The risk-free rate, rRF, is 3.5%. The market risk premium, (rM - rRF), is 5.0%. What is the required rate of return on your investment portfolio?

If you switch $450,000 out of T-bills and invest $300,000 of it in growth stocks and $150,000 of it in mid-cap stocks, what would be the required rate of return on your portfolio?

Explanation / Answer

A) Calculation of Required rate of return Type of stock Beta Risk Premium(%) Calculation of Cost of capital Cost of capital weight WACC (%) T bils 0 5 3.5% + (5%)*0 3.5 10% 0.35 Bonds 0.7 5 3.5% + (5%)*.7 7 15% 1.05 Mid cap stocks 1 5 3.5% + (5%)*1 8.5 35% 2.975 Growth stocks 1.4 5 3.5% + (5%)1.4 10.5 40% 4.2 Required Rate of return on portfolio 8.575 B) Calculation of revised amount invested Type of stock Old Weight Old Amount ($) Adjustment New Amount New Weight T bils 10% 900000 -450000 450000 5 Bonds 15% 1350000 0 1350000 15 Mid cap stocks 35% 3150000 150000 3300000 36.66666667 Growth stocks 40% 3600000 300000 3900000 43.33333333 Total 9000000 9000000 Calculation of Required rate of return Type of stock Beta Risk Premium(%) Calculation of Cost of capital Cost of capital weight (%) WACC (%) T bils 0 5 3.5% + (5%)*0 3.5 5% 0.175 Bonds 0.7 5 3.5% + (5%)*.7 7 15% 1.05 Mid cap stocks 1 5 3.5% + (5%)*1 8.5 36.67% 3.11695 Growth stocks 1.4 5 3.5% + (5%)1.4 10.5 43.33% 4.54965 Required Rate of return on portfolio 8.8916

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