Tut 5

TUT 5 (CHAPTERS 9, 10 AND 13)

Question 1

Florida Company (FC) and Minnesota Company (MC) are both service companies. Their

historical return for the past three years are: FC: -5%, 15%, 20%; MC: 8%, 8%, 20%.

Calculate the variances of return for FC and MC.

Question 2



Calculate the covariance between the returns of FC and MC.

Question 3



Calculate the correlation coefficient between the return of FC and MC.

Question 4


historical return for the past three years are: FC: -5%, 15%, 20%; MC: 8%, 8%, 20%.What is

the variance of the portfolio with 50% of the funds invested in FC and 50% in MC

(approximately)?

Question 5

If the beta of Microsoft is 1.13, risk-free rate is 3% and the market risk premium is 8%,

calculate the expected return for Microsoft.

Question 6

Given the following data for a stock: beta = 1.5; risk-free rate = 4%; market rate of return =

12%; and Expected rate of return on the stock = 15%. Then the stock is:

Question 7

Given the following data for a stock: risk-free rate = 4%; factor-1 beta = 1.5; factor-2 beta =

0.5 factor-1 risk-premium = 8%; factor-2 risk-premium = 2%. Calculate the expected rate of

return on the stock using the two-factor APT model.

Question 8

Given the following data for a stock: risk-free rate = 5%; beta (market) = 1.5; beta (size) =

0.3; beta (book-to-market) = 1.1; market risk premium = 7%; size risk premium = 3.7%; and

book-to-market risk premium = 5.2%. Calculate the expected return on the stock using the

Fama-French three-factor model.

Question 9

Briefly explain the "capital asset pricing model."

Question 10

The market value of Charter Cruise Company's equity is $15 million, and the market value of

its risk-free debt is $5 million. If the required rate of return on the equity is 20% and that on

the debt is 8%, calculate the company's cost of capital. (Assume no taxes.)

Question 11

The market value of Charcoal Corporation's common stock is $20 million, and the market

value of its risk-free debt is $5 million. The beta of the company's common stock is 1.25, and

the market risk premium is 8%. If the Treasury bill rate is 5%, what is the company's cost of

capital? (Assume no taxes.)

Question 12

The market value of XYZ Corporation's common stock is 40 million and the market value of

the risk-free debt is 60 million. The beta of the company's common stock is 0.8, and the

expected market risk premium is 10%. If the Treasury bill rate is 6%, what is the firm's cost

of capital? (Assume no taxes.)

Question 13

The historical returns data for the past three years for Company A's stock is -6%, 15%, 15%

and that of the market portfolio is 10%, 10% and 16%. Calculate the beta for Stock A

Question 14

The historical returns data for the past three years for Company A's stock is -6.0%, 15%, 15%

and that of the market portfolio is 10%, 10% and 16%. If the risk-free rate of return is 4%,

what is the cost of equity capital (required rate of return of company A's common stock)

using CAPM?

Question 15

The historical data for the past three years for the market portfolio are 10%, 10% and 16%. If

the risk-free rate of return is 4%, what is the market risk premium?

Question 16

The historical returns data for the past three years for Stock B and the stock market portfolio

are: Stock B: 24%, 0%, 24%, Market Portfolios: 10%, 12%, 20%. Calculate the covariance of

returns between Stock B and the market portfolio.

Question 17

The historical returns data for the past four years for Stock C and the stock market portfolio

returns are: Stock C: 10%, 30%, 20%,20%; Market Portfolio: 5%, 15%, 25%, 15%. Calculate

the beta for the stock.

Question 18

The historical returns data for the past four years for Stock C and the stock market portfolio

returns are: Stock C: 10%, 30%, 20%,20%; Market Portfolio: 5%, 15%, 25%, 15%. If the

risk-free rate of return is 5%, calculate the required rate of return on the Stock C using

CAPM.

Question 19

A project has an expected risky cash flow of $200, in year-1. The risk-free rate is 6%, the

market rate of return is 16%, and the project's beta is 1.5. Calculate the certainty equivalent

cash flow for year-1.

Question 20

A project has an expected risky cash flow of $500, in year-3. The risk-free rate is 4%, the

market rate of return is 14%, and the project's beta is 1.2. Calculate the certainty equivalent

cash flow for year-3.

Question 21

Briefly describe the factors that determine asset betas.

Question 22

Briefly explain how the use of single company cost of capital to evaluate projects might lead

to erroneous decisions.

Question 23

A firm has an average investment of $1000 during the year. During the same time the firm

has an after tax earnings of $150. If the cost of capital is 10%, what is the net return on

investment?

Question 24

A firm has an average investment of $1000 during the year. During the same time the firm

has an after tax earnings of $150. Calculate the economic value added (EVA) for the firm.

(Cost of capital is 10%)

Question 25

A firm has an average investment of 100,000 during the year. During the same period, the

firm has an after-tax income of $16,000. If the cost of capital is 15%, what is the economic

profit?

Question 26

What is EVA used for?

Question 27

Consider an asset with the following cash flows:

The firm uses straight-line book depreciation. For this project; it writes off $7 per year in

years 1, 2 and 3. The discount rate is 10%. Calculate the economic income in years 1, 2 and

3.

Question 28

What are some of the agency problems associated with capital budgeting?

Question 29

Briefly explain how a plant manager can improve EVA (Economic Value Added)?

Question 30

State and explain the advantages of using EVA as a measure of performance.

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Tut 5