Q1: Calculate risk (standard deviation) of a three-asset portfolio by assigning equal weights.

2

A= 27%, A,B. =103%

2

B= 14%, B,C =107%

2

C= 19%, C,A =105%

b) Calculate the portfolio risk again. Assume security C is a T bill in the portfolio. (5 marks)

Q2: An analyst expects Rf =5.5%, a market return=15.5% and the returns for stock A and B are given below.

Stocks Beta Analysts estimated return

A Stock A is 200 percent more volatile than

the market as a whole

20%

B Stock B is 70 percent as risky as the

market as a whole

14%

i) Show on a graph where Stock A and B would be plotted on SML if they were fairly valued using CAPM. (3 marks)

ii) Plot (on the same graph) returns estimated by analyst.

iii) State whether stock A and B are undervalued/ overvalued?

Q3: Find the reasonable final state of Ks using CAPM as well as DCF approach.

If the rRF = 7%, RPM = 6%, and the firms beta is 1.2, whats the cost of common equity based upon the CAPM? Also calculate the

required rate of return with DCF approach if the current dividend is $4.19 and P0 = $50. The firm has been earning 12% on equity and

retaining 40% of its earnings. This situation is expected to continue. (3)

Q4: Suppose you have invested $2000 today and receive $400 after one year, $700 after 2nd year, $700 after third and -$100 after 4th year.

The discount rate is 10%. Calculate the following;

a) PBP, b) Discounted PBP, c) IRR, d) MIRR, e) NPV and f) PI Justify acceptance / rejection of the project. (6)

Q5: Company ABC has a capital structure that consists solely of debt and common equity. The company has issued 15-year, 12%

semiannual coupon bond sells for $1,153.72. Its stock currently pays a $2 dividend per share and the stocks price is currently $24.75.

The companys ROE is 15% and paying out 60% of its earnings.its tax rate is 35%; and the company estimates that its WACC is 13.95%.

What percentage of the companys capital structure consists of debt financing? (10)

Q6: Find the reasonable final state of Ks using CAPM as well as DCF approach. If the rRF = 7%, RPM = 6%, and the firms beta is 1.2,

whats the cost of common equity based upon the CAPM? Also calculate the required rate of return with DCF approach if the current

dividend is $4.19 and P0 = $50. The firm has been earning 12% on equity and retaining 40% of its earnings. This situation is expected to

continue. (5)

Q7. What is the optimal capital structure for Chip Co.? Assume that the companys growth rate is 2%. The company is not paying all of

the earnings as dividends hence find stock price? (3)

Dividends Cost of Stock Price

Debt Ratio Per Share Equity (ks)

0% $5.50 12%

25 6.00 12.5

40 6.50 13

50 7.00 13.5

75 7.50 14

Q8. Discuss three capital structure theories in detail (s)