Essay about Corporate Finance Study Notes

1868 Words Oct 21st, 2011 8 Pages
Solutions to Chapter 10 Introduction to Risk, Return, and the Opportunity Cost of Capital capital gain + dividend ($44 − $40) + $2 = = 0.15 = 15.0% initial share price $40

1.

Rate of return =

Dividend yield = dividend/initial share price = $2/$40 = 0.05 = 5% Capital gains yield = capital gain/initial share price = $4/$40 = 0.10 = 10%

2.

Dividend yield = $2/$40 = 0.05 = 5% The dividend yield is unaffected; it is based on the initial price, not the final price. Capital gain = $36 – $40 = −$4 Capital gains yield = –$4/$40 = –0.10 = –10% capital gain + dividend ($38 − $40) + $2 = = 0% initial share price $40
1 + nominal rate of return 1+ 0 −1 = − 1 = −0.0385 = −3.85% 1 + inflation rate 1 + 0.04

3.

a.

Rate of return =
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The results for this period demonstrate the perils of attempting to measure ‘normal’ maturity (or risk) premiums from historical data. While experience over long periods may be a reasonable guide to normal premiums, the realized premium over short periods may contain little information about expectations of future premiums.

10-3

12. If investors become less willing to bear investment risk, they will require a higher risk premium to compensate them for holding risky assets. Security prices of risky investments will fall until the expected rates of return on those securities rise to the now-higher required rates of return.

13.

Based on the historical risk premium of the S&P 500 (7.6 percent) and the current level of the risk-free rate (about 3.5 percent), one would predict an expected rate of return of 11.1 percent. If the stock has the same systematic risk, it also should provide this expected return. Therefore, the stock price equals the present value of cash flows for a one-year horizon.
P0 = $2 + $50 = $46.80 1.111

14.

Boom:

$5 + ($195 − $80) = 150.00% $80 $2 + ($100 − $80) = 27.50% $80 $0 + ($0 − $80) = −100.00% $80

Normal:

Recession: r= 150 + 27.50 + (−100) = 25.83% 3 1 1 1 × (150 − 25.83) 2 + × (27.50 − 25.83) 2 + × (−100 − 25.83) 2 = 10,418.06 3 3 3

Variance =

Standard deviation = variance = 102.07%

15. The bankruptcy lawyer does well when the rest of the economy is floundering, but does

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