QUESTION 1

SBS Transit is expected to pay dividends of 50 cents per share at the end of the year. The company's dividends will then grow by 8% p.a. in periods 2 and 3, and 7% p.a. in periods 4 and 5, before settling down to a perpetual growth rate of 4% p.a.

Required:

(a)Calculate the maximum amount you would be prepared to pay for an SBS Transit share assuming you intend holding them for only two years and assuming a required rate of return of 12% p.a.

(b)Under what circumstances would an annually increasing dividend yield be considered to be a negative indication of a company's prospects?

(c)How much would you be prepared to pay for a share in two years' time that pays a 15c dividend each year and is currently priced at $2? Assume the required rate of return is 7.5% p.a.

QUESTION 2

Monica Chan had bought an investment property four years ago and recently sold the property. She made a profit of $ 200,000 and wants to invest in shares. Hence, Monica met her financial adviser Daisy Lin, CFA, to discuss equity investment options.

Daisy recommended 30 stocks to Monica, drawn from several industries to invest. However, Monica was insisting that Daisy invest a higher proportion of her funds in five of her best-recommended stocks as Daisy had a very strong outlook on these five stocks as compared to the other 30.

REQUIRED:

(a)With respect to Modern Portfolio Theory, analyse Monica's suggestion. Discuss how both systematic and firm-specific risk change as the number of securities in a portfolio is increased.

(b)Explain what beta is and why it is important.

(c)What does it mean when a company has a very high P/E ratio? Give examples of industries in which you believe high P/E ratios are justified and explain why.