Suppose a large institutional investor Zetas portfolio has a beta of 1.6. Another institutional investor Kappas portfolio has a beta of 0.6. Both portfolios have the same Sharpe ratio as that of the market portfolio, which is 0.8, and the standard deviation of Zetas portfolio is 15 percent. Suppose there is a firm called Cunning corporation, whose stocks beta is 2 and it can borrow at the risk free rate, which is 3 percent. Cunnings equity value is 1.2 million and its debt is 1 million. The present value of Cunnings tax shield is 0.35 million. Assuming that both CAPM and the Modigliani-Miller theorem with corporate taxes hold, answer the following questions.

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a) What is the expected return on Zetas portfolio? b) What is the expected return on the market portfolio?

[5 marks]

[5 marks]

c) What is the weight attached to Kappa if we express the market portfolio as a portfolio comprising Zeta and Kappas portfolios?

d) What is the after-tax WACC of Cunning?