Problem 1. Below you are presented with hypothetical stock prices for two different stocks over a ten year period.
a. Calculate the yearly returns for both stocks
| Year |
Stock Price A |
Yearly Return (%) |
| 1 |
$100 |
|
| 2 |
$112 |
12.0% |
| 3 |
$118 |
|
| 4 |
$106 |
|
| 5 |
$110 |
|
| 6 |
$91 |
|
| 7 |
$105 |
|
| 8 |
$125 |
|
| 9 |
$155 |
|
| 10 |
$185 |
|
| Stock Price B |
Yearly Return (%) |
|
|
| $ 65 |
|
| $ 70 |
|
| $ 79 |
|
| $ 83 |
|
| $ 80 |
|
| $ 95 |
|
| $ 94 |
|
| $ 108 |
|
| $ 120 |
|
| $ 125 |
|
b. Calculate the average yearly returns:
c. Calculate the standard deviation:
d. Which if these stocks was less risky? Explain
Problem 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?
Problem 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 $100 million of equity.
a. Calculate the company's overall cost of capital.
Cost of Debt:
Pre-tax Cost of Debt
Tax Rate
After-tax Cost of Debt 0.00%
Cost of Equity:
Cost of Equity
Weights:
Dollar Value ($ in millions) % Amount
Debt
Equity
Total $- 0.0%
Cost of Capital:
Formula:
Calculation:
b. What happens to the cost of equity as more debt gets used relative to equity? Why does this occur?
Attachment:- Assignment Risk and Return.xlsx