Question 3 (this question has three parts, a) b) and c) (18 marks)

Part a.

Example

Deakin Ltd has just recently published following financial information:

Expected earnings per share $20

Deakins market beta 0.8

Earnings per share to be retained by the firm 30%

Growth rate in earnings per share 7% p.a.

Required:

1. Calculate Deakin's P/E ratio if the expected return on the ASX300 is 12% p.a. and the return on 10 year Commonwealth Government Bonds is 4% p.a. What does this ratio tell you?

2. Calculate Deakin's share price using P/E ratio calculated in Part 1. (7+2=9 marks)

Part b.

Discuss why the majority of IPOs are usually underpriced. What role do investment banks play in this process? (4 marks)

Part c.

Distinguish between systematic and unsystematic risk. Can diversification reduce all risk? Why or why not?