Week 5 Problem Set

Answer the following questions and solve the following problems in the
space provided. When you are done, save the file in the format
flastname_Week_5_Problem_Set.docx, where flastname is your first initial
and you last name, and submit it to the appropriate dropbox.

Chapter 10 (pages 345348):

4.
You bought a stock one year ago for $50 per share and sold it today for $55 per
share. It paid a $1 per share dividend today.
a. What was your realized return?
b. How much of the return came from dividend yield and how much came from
capital gain?
20.
Consider two local banks. Bank A has 100 loans outstanding, each for $1 million,
that it expects will be repaid today. Each loan has a 5% probability of default, in
which case the bank is not repaid anything. The chance of default is independent
across all the loans. Bank B has only one loan of $100 million outstanding, which it
also expects will be repaid today. It also has a 5% probability of not being repaid.
Explain the difference between the type of risk each bank faces. Which bank faces
less risk? Why?
22.
Consider the following two, completely separate, economies. The expected return
and volatility of all stocks in both economies is the same. In the first economy, all
stocks move togetherin good times all prices rise together and in bad times they
all fall together. In the second economy, stock returns are independentone stock
increasing in price has no effect on the prices of other stocks. Assuming you are
risk-averse and you could choose one of the two economies in which to invest,
which one would you choose? Explain.
30.
What does the beta of a stock measure?

35.
Suppose the market risk premium is 5% and the risk-free interest rate is 4%. Using
the data in Table 10.6 (also shown above), calculate the expected return of
investing in
a. Starbucks stock.
b. Hersheys stock.
c. Autodesks stock.
Chapter 11 (pages 390396):
2.
You own three stocks: 600 shares of Apple Computer, 10,000 shares of Cisco
Systems, and 5,000 shares of Colgate-Palmolive. The current share prices and
expected returns of Apple, Cisco, and Colgate-Palmolive are, respectively, $500,
$20, $100 and 12%, 10%, 8%.
a. What are the portfolio weights of the three stocks in your portfolio?
b. What is the expected return of your portfolio?
c. Suppose the price of Apple stock goes up by $25, Cisco rises by $5, and ColgatePalmolive falls by $13. What are the new portfolio weights?

d. Assuming the stocks expected returns remain the same, what is the expected
return of the portfolio at the new prices?

50.
Suppose Autodesk stock has a beta of 2.16, whereas Costco stock has a beta of
0.69. If the risk-free interest rate is 4% and the expected return of the market
portfolio is 10%, what is the expected return of a portfolio that consists of 60%
Autodesk stock and 40% Costco stock, according to the CAPM?

Chapter 12 (page 431):

26.
Unida Systems has 40 million shares outstanding trading for $10 per share. In
addition, Unida has $100 million in outstanding debt. Suppose Unidas equity cost of
capital is 15%, its debt cost of capital is 8%, and the corporate tax rate is 40%.

a. What is Unidas unlevered cost of capital?

b. What is Unidas after-tax debt cost of capital?

c. What is Unidas weighted average cost of capital?

27.
You would like to estimate the weighted average cost of capital for a new airline
business. Based on its industry asset beta, you have already estimated an
unlevered cost of capital for the firm of 9%. However, the new business will be 25%
debt financed, and you anticipate its debt cost of capital will be 6%. If its corporate
tax rate is 40%, what is your estimate of its WACC?