Question
1. (a) Share A has a current price of $25.00, a beta of 1.25, and a dividend yield of 6%. If the risk-free rate is
1. (a) Share A has a current price of $25.00, a beta of 1.25, and a dividend yield of 6%. If the risk-free rate is 5% and the market portfolio is expected to return 14% p.a., what should Share A sell for at the end of an investor's 2-year investment horizon?
(b) If, as a result of the disruption caused by the Covid-19 pandemic, the share market return in 2020 turns out to be 20%, explain what will happen if we use an historical average to estimate the expected market risk premium next year. Discuss whether this makes sense and what we should do about it.
(c) Calculate a company's weighted-average cost of capital if the shares have a beta of 1.5, Treasury bills yield 3% p.a., and the market portfolio offers an expected return of 9% p.a. In addition to equity, the company finances 50% of its assets with debt that has a yield to maturity of 7% p.a. The companys corporate tax rate is 28%.
(d) Your business can continue to use an older, less efficient machine at a cost of $8,000 annually. Alternatively, you can purchase a more efficient machine for $12,000 today plus $5,000 annual maintenance costs at the end of each year. If the new machine lasts 5 years and the cost of capital is 15% p.a., which alternative should you choose? Show all your workings and explain your choice.
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