1. Use the following information to answer questions below.

State Probability Return on A Return on B

Boom .25 15% -3%

Normal .65 10% 4%

Bust. .10 4% 9%

a. Calculate the expected returns for A and B.

b. Calculate the standard deviations for A and B.

c. Calculate the covariance of the two companies.

d. What is the expected return on a portfolio with weights of 40% in asset A and 60% inasset B?

e. What is the standard deviation of a portfolio with weights of 40% in security A and the remainder in security B?

f. What is the correlation coefficient of the two securities?

2. Given the following information, what is the companys WACC?

Common Stock:1 million shares outstanding, $40 per share, $1 par value, beta = 1.3

Bonds:10,000 bonds outstanding, $1,000 face value each, 8% annual coupon, coupons paid semi-annually, 22 years to maturity, market price = $1,101.23 per bond

Preferred Stock:50,000 shares, $7 coupon payment, market price = $108,par value $100

Market risk premium = 8.6%, risk-free rate = 4.5%, marginal tax rate = 34%

3. Margo Corporation is a major producer of lawn care products. Its stock currently sells for $80 per share; there are 10.5 million shares outstanding. Margo also has 400,000 bonds outstanding ($1000 face value per bond). These 10-year bonds pay annually, have a current yield of 10% and trade at 90% of face value. The risk free rate is 8%, the market risk premium is 9%, and Margo has beta equal to 2. The corporate tax rate is 34%.

a. Margo is considering expansion of its facilities. Use the SML to determine the cost of equity.

b. Compute the WACC for Margo.