Problem:
You are considering acquiring a firm that you believe can generate expected cash flows of $14,000 a year forever. However, you recognize that those cash flows are uncertain.
Required:
Question 1: Suppose you believe that the beta of the firm is .8. How much is the firm worth if the risk-free rate is 4% and the expected rate of return on the market portfolio is 9%?
Question 2: How much is the overvalue of the firm if its beta is actually 1.1?
Note: Provide support for your underlying principle.