You are considering acquiring a firm that you believe can generate expected cash flows of $12,000 a year forever. However, you recognize that those cash flows are uncertain.

a.	Suppose you believe that the beta of the firm is .6. How much is the firm worth if the risk-free rate is 3% and the expected rate of return on the market portfolio is 8%? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Value of the firm

$

b.	How much is the overvalue of the firm if its beta is actually 1.0? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Overvalue

$

2.

Suppose that the S&P 500, with a beta of 1.0, has an expected return of 14% and T-bills provide a risk-free return of 5%.

a.

What would be the expected return and beta of portfolios constructed from these two assets with weights in the S&P 500 of (i) 0; (ii) .25; (iii) .50; (iv) .75; (v) 1.0? (Leave no cells blank - be certain to enter "0" wherever required. Do not round intermediate calculations. Round your answers to 2 decimal places.)

		Expected return			Beta
(i)	0		%
(ii)	.25		%
(iii)	.50		%
(iv)	.75		%
(v)	1.0		%

b.	How does expected return vary with beta? (Do not round intermediate calculations.)

The expected return (Click to select) increases decreases by % for a one unit increase in beta.