11. (Gavin's final) Mr. Jones was considering a new grapefruit venture that would generate a random sequence of yearly cash flows. He asked his son, Gavin, "People tell me I should use a cost of capital figure to discount the stream They say it's based on the CAPM Have you given up on that? I haven't heard you talk about it for awhile." Gavin replied, "Special conditions are required to justify it for more than one period. We had a complicated final exam question on it." Consider a two year model The risk-free rate for each is r The (random) rates of return for the Markowitz portfolio in the two years are 1 and 2, respectively, and they are independent. There is a single random cash flow x at the end of the second year. Denote by X and X the random variable x2 given the information at times zero and one, respectively, and let Eo and E, denote expectation at times zero and one Likewise let Ve and V, denote the value at time zero and one, respectively, of receiving x at time 2 Assume that Eo (E[x]]=E[20] and that cov[x2/V, ra] is independent of the information received at time one Show that the value at time zero of receiving x at time 2 is Eolx30] where = Find V, and B B = cov[V/V, 11]/0