Use the following for questions 16 through 17: What is the Expected Return for a

Question

Use the following for questions 16 through 17: What is the Expected Return for a security with a Beta of 0.75? 20.00% 12.50% 15.00% If you have a stock with a Beta of 1.5 and it will pay you a $3 dividend, and you expected the price to be $81 in a year, what would you pay for the stock today if the stock is assumed to be fairly priced? $100..80 $84.00 $70.00 Which of the following is not a capital budgeting decision? Asset sales at the end of the project Incremental overhead cost for the project Borrowing money to repurchase common stock in the market Which of the following cash flow should be discounted by WACC? A company's total free cash flow. Coupon payments from corporate debt. Dividend payments from holding a company's stock.

Explanation / Answer

16 Expected Return = 20% Rf + (Rm - Rf)*Beta = 20% Rf = Risk Free Rate = 5% Beta = 1.5 Hence, 5% + (Rm - 5%) * 1.5 = 20% or, (Rm - 5%)*1.5 = 15% or, Rm = 10% + 5% or, Rm = 15% When Beta is 0.75% E (R ) = 5% + (15% - 5%) * 0.75 = 5% + 7.5% = 12.50% Hence, the correct answer is Option B 17 As per Constant Dividend Growth Model, Price = Expected Divided/E( r) - g or, 81 = 3*(1+g)/(0.20 - g) or, 81*(0.20-g) = 3(1+g) or, 5.4 - 27g = 1 + g or, 28g = 4.4 or, g = 15.7143% Current Price as per above formula = $3/(0.20 - 0.157143) = 3/0.042857 = $70 Hence, the correct answer is Option C 18 The correct answer is Option C Its is financing decision which changes the cost of capital but not the cashflow The other two options are relevant cashflows which affect the net present value of project 19 The correct answer is Option A Company's total free cash flow is discounted to know the value of company using discounting cashflow technique

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