Problem 1

You have decided to invest 30 percent in X; 30 percent in Y; and 40 percent in Z. The probability of the state of the economy is Boom 25%; Normal 60%; and, Bust 15%. The rate of return for stock X is Boom .20; Normal .15; and, Bust .00. The rate of return for stock Y is Boom .35; Normal .10; and, Bust -.30. The rate of return for stock Z is Boom .60; Normal .05; Bust -.40.

   A] What is the portfolio expected return?

   B] If the expected T-bill rate is 1-5 percent, what is the expected risk premium on the portfolio?

Problem 2

You have been given the following information on two corporations; you are to assume that the securities are correctly priced. My Corp, Inc. has a Beta of 1.25 and an Expected Return of .145; Your Corp, Inc. has a Beta of .75 and an Expected Return of .095. Based on the CAPM, what is the:

   A] expected return on the market?

   B] the risk-free rate?

Problem 3

Your Corp, Inc. has a corporate tax rate of 35%. Please calculate their after tax cost of debt expressed as a percentage. Your Corp, Inc. has several outstanding bond issues all of which require semiannual interest payments. Bond A has a coupon rate of 4.0%; a price quote 104; maturity is 6 years; and the face value is $50,000. Bond B has a coupon rate of 6.5%; a price quote of 109; maturity is 9 years; and the face value is $30,000. Bond C has a coupon rate of 9.2%; a price quote of 95; maturity is 16 years; and the face value $60,000. Bond D has a coupon rate of 9.9%; a price quote of 110; maturity is 24 years; and the face value is $40,000

Problem 4

Your Corp, Inc.'s data is as follows:

   Beta; 1.30
   Recent dividend; $.90
   Expected dividend growth; 7%
   Expected return of the market; 14%
   Treasury Bills are yielding; 4%
   Most recent stock price; $65

A] Using the DCF method, calculate the cost of equity.

B] Using the SML method, calculate the cost of equity.

C] The answers in [A] and [B] are very different. Why?