Questions 1, 2 and 3

Question 1
(a) Lau Berhad just paid a dividend of $2.15 per share on its stock. The dividends are
expected to grow at a constant rate of 4% per year indefinitely.
Required:
(i) If investors require a return of 10.5% on the company’s stock, what is the current
price ? (4
marks)
(ii) What will the price be in 3 years ? (4 marks)
(iii) What will the price be in 15 years ? (4 marks)
(b) The next dividend payment by Lee Berhad will be $2.34 per share. The dividends are
anticipated to maintain a growth rate of 4.5% forever. If the stock currently sells for
$37 per share, what is the required return ? (3 marks)
(c) Chong Berhad will pay a dividend of $3.28 per share next year. The company pledges
to increase its dividend by 3.75% percent per year indefinitely. If you require a return
of 10% on your investment, how much will you pay for the company’s stock today ?
(3
marks)
(d) Leong Berhad pays a constant $8.25 dividend on its stock. The company will maintain
this dividend for the next 13 years and will then cease paying dividends forever. If the
required return on this stock is 11.2%, what is the current share price ?
(2
marks)
(e) Ali Berhad, Ahmad Berhad and Ah Kau Berhad each will pay a dividend of $3.65
next year. The growth rate in dividends for all 3 companies is 4%. The required return
for each company’s stock is 8%, 11% and 14% respectively.
Required:
(i) What is the stock price for each company ? (3 marks)
(ii) What do you conclude about the relationship between the required return and the
stock price ? (2
marks)
[Total : 25 marks]
Question 2
(a) John plc has a proposal costing £800. Using a 10 per cent cost of capital, compute the
Expected Net Present Value (ENPV), standard deviation and coefficient of variation,
assuming independent interperiod cash flows.
Probability Year 1 Net Cash Year 2 Net Cash
Flow (£) Flow (£)
0.2 400 300
0.3 500 400
0.3 600 500
0.2 700 600
(11 marks)
(b) The returns on investment in two projects, X and Y, have standard deviations of 30%
and 45% respectively. The correlation coefficient between the returns on the two
investments is 0.2. What is the standard deviation of a portfolio containing equal
proportions of the two investments? (4 marks)
(c) You own a portfolio that is invested 35% in Stock X, 20% in Stock Y, and 45% in
Stock Z. The expected returns on these stocks are 8%, 11% and 10% respectively,
what is the expected return on the portfolio ?
(4 marks)
(d) You own a portfolio that is invested 35% in Stock X, 20% in Stock Y, and 45% in
Stock Z. The expected returns on these 3 stocks are 9%, 15% and 12%, respectively.
What is the expected return on the portfolio ?
(2 marks)
(e) Based on the following information, calculate the expected return:
State of Economy Probability of State of Portfolio Return If

Economy State Occurs
Recession 0.20 -0.08
Boom 0.80 0.15
(2
marks)
(f) Based on the following information, calculate the expected return:
State of Economy Probability of State of Portfolio Return If

Economy State Occurs
Recession 0.10 -0.15
Normal 0.60 0.09
Boom 0.30 0.23
(2
marks)
[Total : 25
marks]
Question 3
(a) The ordinary shares of Firm A have a Beta of 1.23. The risk-free rate of interest is 5
per cent, and the risk premium achieved on the market index over the past 20 years
has averaged 11.5 per cent p.a. What is the future expected return on A’s shares? If
you believe that overall market returns will fall to 8 per cent in future years, how does
your answer change ? (2
marks)
(b) Supply the missing links in the table:

ERi Rf β ERm
(i) 19% ? 1.10 18%
(ii) 17% 5% ? 12%
(iii) ? 4% 0.75 10%
(iv) 15% 7% 0.65 ?
(4
marks)
(c) Which of the following shares are over-valued?

Beta Current Rate of
Return
A 0.7 7%
B 1.3 13%
C 0.9 9%
The risk-free rate is 5 per cent, and the return on the market index is 10 per cent.
(5
marks)
(d) A stock has a beta of 1.15, the expected return on the market is 10.3%, and the risk-
free rate is 3.1%. What must the expected return on this stock be ?
(2
marks)
(e) A stock has an expected return of 10.2%, the risk-free rate is 3.9%, and the market
risk premium is 7.2%. What must the beta of this stock be ? (2
marks)
(f) A stock has an expected return of 10.45%, its beta is 0.93 and the risk-free rate is
3.6%. What must the expected return on the market be ? (2
marks)
(g) A stock has an expected return of 11.85%, its beta is 1.24, and the expected return on
the market is 10.2%. What must the risk-free rate be ? (3 marks)
(h) Suppose the risk-free rate is 8%. The expected return on the market is 16%.
Required:
(i) If a particular stock has a beta of 0.7, what is its expected return based on the CAPM ?
(2
marks)
(ii) If another stock has an expected return of 24%, what must its beta be ?
(3
marks)
[Total : 25 marks]

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Question 1

(e) Based on the following information, calculate the expected return:

State of Economy Probability of State of Portfolio Return If

(f) Based on the following information, calculate the expected return:

State of Economy Probability of State of Portfolio Return If

(b) Supply the missing links in the table:

(c) Which of the following shares are over-valued?

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