1. Below you are presented with hypothetical stock prices for two different stocks over a ten year period.
| Year |
Stock Price A |
Yearly Return (%) |
|
Stock Price B |
Yearly Return (%) |
|
|
|
|
|
|
| 1 |
$ 100 |
|
|
$ 65 |
|
| 2 |
$ 112 |
12.0% |
|
$ 70 |
|
| 3 |
$ 118 |
|
|
$ 79 |
|
| 4 |
$ 106 |
|
|
$ 83 |
|
| 5 |
$ 110 |
|
|
$ 80 |
|
| 6 |
$ 91 |
|
|
$ 95 |
|
| 7 |
$ 105 |
|
|
$ 94 |
|
| 8 |
$ 125 |
|
|
$ 108 |
|
| 9 |
$ 155 |
|
|
$ 120 |
|
| 10 |
$ 185 |
|
|
$ 125 |
|
a. Calculate the yearly returns for both stocks
b. Calculate the average yearly returns:
c. Calculate the standard deviation:
d. Which if these stocks was less risky? Explain
2. Assume the risk-free rate is 3.5%, the beta of a company is 0.8 and the market-level return is 12%.
a. Provide the CAPM equation and use it to solve for the required return of the company's equity.
CAPM Equation:
Required Return:
b. Now assume the beta is 1.6. What is the required return of the company's equity?
Required Return:
c. What happens as beta increases?
3. Nessumsar compay develops educational materials. It has a pre-tax cost of debt of 8.0% and a cost of equity of 11.0%. It has a marginal tax rate of 40%, $50 million of debt and $100 million of equity.
a. Calculate the company's overall cost of capital.
b. What happens to the cost of equity as more debt gets used relative to equity? Why does this occur?