Q1/ Selena invests the following sum of money in common stock having expected returns as follows:
Common Stock Amount Invested in $ Expected Return Beta of Stock( β)
WOOPS 5,000 0.14 0.6
KBOOM 10,000 0.16 0.8
JUDY 6,000 0.17 0.85
UPDWN 8,000 0.13 0.5
SPROUT 4,500 0.20 1.1
RINGG 7,500 0.15 0.65
EIEIO 9,000 0.18 0.9
a) What is the expected return on her portfolio based on the amount invested above?
b) Calculate the systematic risk, β of the portfolio.
c) Does the portfolio have more or less systematic risk compared to the average market portfolio?
d) If return on the market (Rm) is 14% and the risk free rate (Rf) is 4%, what would be the return of the portfolio according to Capital Asset Pricing Model (CAPM)?
e) If Selena wants to get 12% return from this portfolio, is this the appropriate portfolio for her? Explain your reason using your answer in (A) and (D).
f) If she still wants to invest in this portfolio, what should she do in terms of adjusting the weight of the stock? Give your answer based on the amount invested in UPDWN and SPROUT stocks.
Q2/ Rowing Boats Inc. has asked a group of financial consultants to help them determine their component and average costs of capital. The consultants have been able to gather the following information: The current price of the firm's 10-year, $7000 par value, zero-coupon bonds is $3,134. The price of the firm's preferred stock, par value of $100, is $139 and pays dividends of 9% per year (note: dividends are calculated based on par value). The common stock has a current price of $27 per share, expects to pay $2 per share in annual dividends next year, and has an expected annual growth rate in dividends of 6%. The market value of the sources of financing is debt at $2,000,000, common stock at $5,500,000, and preferred stock at $500,000. The firm is in a 40% tax bracket.
a. What is the after tax cost of debt the firm's debt?
b. What is the firm's cost of preferred stock?
c. What is the firm's cost of equity?
d. What is the firm's weighted average cost of capital adjusted for taxes?