1. A portfolio manager believes that Wells Fargo (WFC) is a good candidate as a value stock. WFC currently trades at $50 and the consensus estimate for FY1 earnings per share is $5.68. The Dow Jones U.S. Financials index (DJUSFI) has a P/E of 11.

1a. Assume the earnings estimate for WFC does not change. The manager believes that the WFC share price will change such that its P/E ratio will become equal to that of the DJUSFI. What is the target price for WFC?

1b. If the WFC share price does converge to the managers target price, what will be the resulting holding period return? Assume WFC does not pay dividends.

1c. The annual return on the DJUSFI has averaged 12% recently. Using this historical return as the required return on WFC, what alpha would the manager earn if it takes eight months for the share price to converge to the target price?

1d. WFC has a beta of 1.27, the expected annual return on the market is 9%, and the YTM on the 1-year T-Bill is 2.5%. If the manager uses CAPM to estimate the required return on the stock, what will be the alpha if price convergence requires 8 months?

1e. Using the CAPM estimate for the required rate of return on WFC, what will be the alpha if 30 months are required for price convergence?

1f. Holding the target price constant, according to CAPM how long can the manager hold a long position in WFC before alpha becomes negative?