1. You have the opportunity to invest in a security that produces the following risky cash flows depending on the state of the economy. Strong Economy Weak Economy t=1 165 125 t=2 176 136 t=3 186 146 The probability of a strong economy is 70%. Investing in the security will incur annual cost of EUR 27 for administration of the securities account. The risk-free interest rate is 2% and given the risk of the project, you demand a risk premium of 3%. The current price of the security is EUR 296.99. a) What is the expected cash flow of the security? b) What is the fair price of the security (=arbitrage-free price)? c) How can you exploit this arbitrage opportunity and what is the arbritrage profit you can realize today? 2. For the stocks A and B as well as the market portfolio you observe the following information: Correlation with Market Return Expected Return Volatility Expected Market Return Volatility of Market Return Risk-free Rate A B 0.75 0.46 8.50% 7.00% 11.89% 6.83% 11.56% 11.45% 1.84% a) Compute the market beta for both stocks! b) Compute the required return based on the capital asset pricing model for both stocks! c) Compute alpha for both stocks! Decide which stock is preferred in terms of alpha and beta! 3. You are asked to compute the free cash flows of a company for the next 5 years. You receive the following relevant selected information from the incremental earnings forecast: 0 5 Sales Costs of Goods Sold Unlevered Net Income Depreciation 1 24.61 14.77 3.51 0.64 2 26.60 15.96 4.74 0.64 3 26.97 16.18 6.80 0.64 4 26.48 15.89 7.54 0.64 -5.86 4.99 0.64 In additon, you know that 15% of sales and costs of goods sold must be allocated to the working capital. The weighted average cost of capital is 8%. The company expects a growth rate of its free cash flows of 2% after year 5. a) Compute the free cash flows of the company! b) What is the estimated firm value of the company using the Discounted Free Cash Flow Model? 1. You have the opportunity to invest in a security that produces the following risky cash flows depending on the state of the economy. Strong Economy Weak Economy t=1 165 125 t=2 176 136 t=3 186 146 The probability of a strong economy is 70%. Investing in the security will incur annual cost of EUR 27 for administration of the securities account. The risk-free interest rate is 2% and given the risk of the project, you demand a risk premium of 3%. The current price of the security is EUR 296.99. a) What is the expected cash flow of the security? b) What is the fair price of the security (=arbitrage-free price)? c) How can you exploit this arbitrage opportunity and what is the arbritrage profit you can realize today? 2. For the stocks A and B as well as the market portfolio you observe the following information: Correlation with Market Return Expected Return Volatility Expected Market Return Volatility of Market Return Risk-free Rate A B 0.75 0.46 8.50% 7.00% 11.89% 6.83% 11.56% 11.45% 1.84% a) Compute the market beta for both stocks! b) Compute the required return based on the capital asset pricing model for both stocks! c) Compute alpha for both stocks! Decide which stock is preferred in terms of alpha and beta! 3. You are asked to compute the free cash flows of a company for the next 5 years. You receive the following relevant selected information from the incremental earnings forecast: 0 5 Sales Costs of Goods Sold Unlevered Net Income Depreciation 1 24.61 14.77 3.51 0.64 2 26.60 15.96 4.74 0.64 3 26.97 16.18 6.80 0.64 4 26.48 15.89 7.54 0.64 -5.86 4.99 0.64 In additon, you know that 15% of sales and costs of goods sold must be allocated to the working capital. The weighted average cost of capital is 8%. The company expects a growth rate of its free cash flows of 2% after year 5. a) Compute the free cash flows of the company! b) What is the estimated firm value of the company using the Discounted Free Cash Flow Model