(a) In relation to the Capital Asset Pricing Model (CAPM):

i. Explain each of the terms in the equation below:

RE= RF + (RM -RF )

ii. Interpret the equation when =1

(b) Find the Weighted Average Cost of Capital (WACC) for a project with the following

data: risk-free rate =1.0 %; Beta =0.8; excess market return over the risk-free rate

=6%; cost of debt= 7%; corporation tax rate =25%; optimal debt to total assets = 0.3

(c) Holding a sum of money as a diversified portfolio of two similar assets is expected to

reduce the risk (standard deviation or variation of returns) compared with holding just

a single asset where the assets have independent returns. Discuss what difference it

would make if the returns on the two assets were either (i) negatively or (ii) positively

correlated