Fundamentals of Corporate Finance (Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate)
9th Edition
ISBN: 9781259722615
Author: Richard A Brealey, Stewart C Myers, Alan J. Marcus Professor
Publisher: McGraw-Hill Education
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Chapter 11, Problem 5QP
Risk Premiums and Discount Rates. Top hedge fund manager Sally Buffit believes that a stock with the same market risk as the S&P 500 will sell at year-end at a price of $50. The stock will pay a dividend at year-end of $2. What price should she be willing to pay for the stock today? Assume that risk-free Treasury securities currently offer an interest rate of 2%. Use Table 11.1 to find a reasonable discount rate.
TABLE 11.1
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Top hedge fund manager Sally Buffit believes that a stock with the same market risk as the S&P 500 will sell at year-end at a price of $49. The stock will pay a divided at year-end of $3.00. Assume that risk-free Treasury securities currently offer an interest rate of 2.1%
Average rates of return on Treasury bills, government bonds, and common stocks, 1900-2017 (figures in percent per year) are as follows
Portfolio
Average Annual Rate of Return (%)
Average Premium (Extra return versus Treasury bills) (%)
Treasury bills
3.8
Treasury bonds
5.3
1.5
Common stocks
11.5
7.7
What is the discount rate on the Stock?
7.7%+ 2.1% =9.8%
What price should she be willing to pay for the stock today?
Price= ($3.00 + $49)/ (1+0.098) = $47.36
Top hedge fund manager Sally Buffit believes that a stock with the same market risk as the S&P 500 will sell at year-end at a price of $50. The stock will
pay a dividend at year-end of $2. Assume that risk-free Treasury securities currently offer an interest rate of 2%.
Average rates of return on Treasury bills, government bonds, and common stocks, 1900-2017 (figures in percent per year) are as follows.
Average Premium
(Extra return
versus Treasury
bills) ($)
Average Annual
Rate of Return
ipped
Portfolio
($)
3.8
Treasury bills
Treasury bonds
5.3
1.5
Common stocks
11.5
7.7
Book
Ask
a. What is the discount rate on the stock? (Enter your answer as a percent rounded to 2 decimal places.)
Print
eferences
Discount rate
9.70 %
b. What price should she be willing to pay for the stock today? (Do not round intermediate calculations. Round your answer
decimal places.)
Stock price
The following graph plots the current security market line (SML) and indicates the return that investors require from holding stock from Happy Corp. (HC). Based on the graph, complete the table that follows.
For graph see image 13a
CAPM Elements
Value
Risk-free rate (rRFRF)
Market risk premium (RPMM)
Happy Corp. stock’s beta
Required rate of return on Happy Corp. stock
An analyst believes that inflation is going to increase by 2.0% over the next year, while the market risk premium will be unchanged. The analyst uses the Capital Asset Pricing Model (CAPM). The following graph plots the current SML.
Calculate Happy Corp.’s new required return. Then, on the graph, use the green points (rectangle symbols) to plot the new SML suggested by this analyst’s prediction.
Happy Corp.’s new required rate of return is _____?.
For grapgh see image 13b
The SML helps determine the level of risk aversion among investors.…
Chapter 11 Solutions
Fundamentals of Corporate Finance (Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate)
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