You are evaluating a potential investment in Southwest Airlines (SWA) common stock. You have gathered the following information on Southwest: You will value SWA using a dividend discount model, and assume constant long-term growth of dividends. You use the CAPM to estimate a stocks required return.

Southwests beta = 1.2

Last years annual dividend = $2.43.

Your estimated long term growth rate of dividends is 5.5% per year (and the market agrees with you.)

You estimate the annual risk-free rate (30-yr. T-Bond rate) = 3.5%

You estimate that the expected average annual return on the market portfolio over the long term (S&P 500 Index) = 9%

You estimate that the expected annual return for SWA = 16.5%

1. (6) What is your required return for SWAs stock? Remember to show all work for all parts.

2. (6) Interpret the specific beta (1.2) for SWA. Explain in meaningful, practical terms what the beta of 1.2 means. Make sure to explain what the specific number 1.2 means in practical terms, as part of your interpretation.

3. Looking at the graph above, answer 1-4. Put your answers for 1-3 below, not on the graph. Use words, not symbols. Answer part 4 on the graph itself.

1 .(2). What is the variable being measured on the horizontal axis (A)?

1. (4) What are the two variables being measured on the vertical axis (B)?

2. (2) What does the point where the SML intersects the Y axis ( C) represent in terms of the SML?

4. . (4) Plot the SWA stocks expected return (with an x) on the graph above Indicate (type) numerical values for the E(R) on both the horizontal and vertical axis

4. (2) Is the stock efficiently valued (correctly valued, in equilibrium) based on your analysis? Just answer

yes or no.

5. (2) Based on your estimates, what is the abnormal return (alpha,) for your stock? (I want a number, not an explanation here.)

6. (2) Should you a. buy SWA, b. sell/sell short SWA, . Just list buy, sell/sell short, no explanation is necessary.

(5) What is your estimate of the intrinsic value of SWA stock?