1. Assume the following information about the market and XYZ stock\'s beta=1.50,

Question

1. Assume the following information about the market and XYZ stock's beta=1.50, the risk-free rate is 3.5%, the market risk premium ( return to the market less the risk-free rate) is 10%. Using the CAPM what is the expected return to the stock?

A. 18.50%

B. 7.5%

C. 27.0%

D. 13.5%

2. Project A has an NPV of $20,000 and PI of 1.5. Project B has an NPV of $10,000 and PI of 1.3. Both projects have equal lives. Which project is preferred?

A. Project A

B. Project B

C. Indifferent between projects

D. none of the above

Explanation / Answer

1) Solution:

Calculation of expected return to the stock by using Capital Asset Pricing Method:

XYZ stock's beta is 1.50,

Risk free rate is 3.5%

Market risk free premium (Return to the market - Risk free rate) is 10%

Formula for calculating expected return to stock by CAPM model is as follows:

E(R) = Rf + ß( Rmarket - Rf )

E(R) = Expected return to the stock

Rf = Risk free rate

( Rmarket - Rf ) = Market risk premium

Expected Return=Risk-Free Rate+ß (Risk Premium)

=Risk-Free Rate+[Beta×(Market Return–Risk-Free Rate)]

  E(R) = Rf + ß( Rmarket - Rf )

= 3.5%+1.50(10%)

= 0.035+1.50(0.1)

= 0.035+0.15

=0.185

=18.50%

Expected rate of return for the stock is 18.50%

So, the answer is Option (A). 18.50%

2). Solution:

Project A has the Net Present Value of $20,000 and Profitability index is 1.5

Project B has the Net Present Value of $10,000 and Profitability index is 1.3

By, these you came to know that Project A has the higher NPV and PI. So, Project A is preferred to the company.

So, the answer is option(A): Project A

Related Questions

Navigate

• Browse (All)
• Browse 1
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.