You founded a start-up company which has been successful, and is about to issue publicly-traded shares for the first time. You estimate that the correlation between the returns of your shares and the overall market is 0.4 for the foreseeable future; the standard deviation of your company's returns is fairly high, at 50% per year. The standard deviation of the market return is much lower, at 16% per year. The risk-free rate is 2% per year and the expected market risk premium is 6% per year.

 

a. If the CAPM holds, what will the beta on your company's shares be?

b. If the CAPM holds, what will the required return on your company's cash flows be?

c. The company is not expected to pay a cash dividend until 5 years from now (at end of Y5). At that time, the dividend is expected to be $4.00 per share; the dividend is expected to grow at 10% per year for 3 years. After that time, the growth rate (in Y9) will slow to 3% per year in perpetuity. Given this info, what is the value of the start-up today?

d. After going public, the shares of your company start to trade at $60 per share. What is the required return implied by this price?

e. Assuming that the risk-free rate and the beta of your company is correct, what is the expected market risk premium implied by the required return that you calculated?