2) Please solve for each of the following problems: A) A stock has a Beta of 1.8

Question

2) Please solve for each of the following problems: A) A stock has a Beta of 1.8, the expected retum on the market is 7 1/2% and the Treasury-Bill rate is 4 1/2%. What is the expected return for this stock? Briefly explain your results (5 3% and the market risk premium, is 6 3/4%, what must be the Beta for this stock? Briefly C) A stock has an expected return, relative to the market, of 15 1/4%, its Beta is 2.6, and the points). B) A stock has an expected return, relative to the market, of 121/2%, the Treasury-Bill rate is explain your results and how this compares to the average market Beta (5 points). Treasury-Bill rate is 4 3/4%, what must be the expected return on the market for this stock? Briefly explain your results (5 points) D) Rapid Start, Inc. is about to experience a 9 year ultra growth phase and will not pay dividends during that time. However, management promises that this growth initiative will be so successful that the company can then pay out a $9.50 per share dividend that will then grow ata rate of 10% per year. What is the maximum price you are willing to pay for Rapid Start's stock if your required annual return is 14? (5 points).

Explanation / Answer

A. expected return using CAPM approach= 9.9%

B. using CAPM expected return= risk free rate +beta* market risk premium

12.5%= 3% +beta*6.75%

beta= (12.5%-3%)/6.75%= 1.4074

C. Using CAPM formula

15.25% = 4.75%+ 2.6 * market risk premium

market risk premium= 4.04%

market expected return= market risk premium+risk free rate= 4.04%+4.75%= 8.79%

D.

First step is to calculate share price at the end of year 9 then discount it to present day.

Share price at the end of year 9 = dividend at the end of year 10/ (required rate-growth rate)= 9.5 /(14%-10%)= 237.5

present value of share price today= future value / (1+r)^n

r= rate of interest= 14%

n= number of years= 9

present vlaue= 237.5 / (1+0.14)^9 = 73.03

maximum price willing to pay= 73.03

Security Risk free rate Beta Market return Market premium Expected return workings Expected return a b c d=c-a e= a+ b*d f A 4.5% 1.8 7.50% 3.00% 0.045+1.8*0.03 9.90%

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