1

You discover an investment costing $3,000 which has an expected total return of 15% pa, but a required return of only 11% pa. Of the 15% pa total expected return, the capital return is expected to be 8% pa. Assume that the required return of 11% remains constant, the dividends can only be re-invested at 11% pa and all returns are given as effective annual rates.

Which of the following statements is NOT correct?

a.

The expected dividend return is 7%

b.

The investments price at time t=20 would be $49,099.61

c.

When plotted on the Security Market Line, the investment would have a positive alpha.

d.

The investment is currently under-priced

e.

You would use a discount rate of 11% to find the NPV of this investment

2

Use the following information to value a firms assets.

Assume the following:

• the market value of the firm's assets is expected to remain constant over time so the firm doesn't grow and can be valued as a level perpetuity,
• the firm has a constant debt-to-assets ratio,
• the bonds are priced at par, and
• the stock's expected capital returns are zero.

Relevant data:

• The number of shares on issue is 2 million and the number of bonds is 1 million
• The constant annual dividend per share is $5
• The bonds have an annual fixed coupon payment of $4
• 10-year government bonds have a yield of 3% and the market risk premium is 5%
• The beta of levered equity is 1.6
• The beta of the bonds is 1.3

Which of the following is the market value of the levered firms assets?

a.

$140.9 million

b.

$133.0 million

c.

$93.2 million

d.

$112.6 million

e.

$102.4 million