You are considering acquiring a firm that you believe can generate expected cash

Question

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.

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.)

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.)

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.)

Explanation / Answer

Beta                 0.60 Risk free                 0.03 Expected return on Market portfolio                 0.08 Return = Risk Free return +Beta*Market risk premium Return=3%+.6*8%= 3% + 4.8% = 7.8% Cash Flows        12,000.00 Value of firm (12,000/7.8%)    153,846.15 If Beta is 1 Return = Risk Free return +Beta*Market risk premium Return=3%+1*8%= 3% + 8% = 11% Cash Flows        12,000.00 Value of firm (12,000/11%)    109,090.91 Overvaluation of firm(153,846-109090.91)      44,755.24

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