Question 2 A firm has just announced Earnings per share (EPS) of $10 on 1 Apr 20XX. Like before, it is expected to pay 20% as dividends to its shareholders but only for the coming five years when earnings are expected to be flat. Thereafter, dividends are set to grow by 10% annually for the subsequent 5 years when overseas production kicks in. Dividends are to set to remain static as overseas markets mature from that point. Cost of capital is 15%.

(a) Based on the above, appraise the value of the firms stock on 1 Apr 20XX? (3 marks)

(b) On 1 May 20XX, there is great sell-off of the firms stock. Shortly after, the firm announces that overseas production will be delayed because of the pandemic. Is arbitrage possible? Which form of market efficiency best explains the scenario? Discuss. (4 marks)

(c) If the 10-year Treasury bond yields return of 4%, the market portfolio yields return of 5% and the firms stock beta is 1.2, calculate the return of the firms stock. (2 marks)

(d) Investors are rewarded for relevant risk that they bear. What is a good measure of this relevant risk? Discuss with the aid of a graph and the relevant axes a theory you have learned in class. (4 marks)

(e) Using the same graph in part (c), mark where Stock A, which is overvalued by the market, will appear on the graph. Illustrate where Stock B, which is undervalued by the market, will appear. (2 marks)