Problem Set # 3  (due 3/16, 4 p.m.)

1) Ergodic Inc.'s stock has a beta of 1.48 and an expected return of 16.354%.  The market portfolio has an expected return of 12.25% .

a) What is the riskfree return?

b) What is the risk premium for the market portfolio?

c) What is the risk premium for the stock?

d) At the end of the year, the actual return for the market portfolio turns out to be 4.6%.  If the actual return for the stock is 7.5%, what is the stock's abnormal return for the year?

(15 points)  

2) Ramotswe Corp.’s stock has a beta of -0.26, and a required return of 0.561% per year.   A stock portfolio with beta of 0.84 has a required return of 10.626% per year.   

a) What is the expected return for a stock with a beta of 1.2?

b) What assumptions are you making, if any, to answer this question (other than the CAPM)

(15 points)

3) Perpendicular Pumpkins' stock has a beta of 0.72.  Given the following information,  

a) what is the required return for the stock, using a short-term riskfree rate?

b) what is the required return for the stock, using a long-term riskfree rate?

       (10 points)

4) McKinley Morganfield Paints Inc. has a debt-to-value ratio of 0.36.  Their Household division has a value of $569 million and an asset beta of 1.24, while the Industrial division has a value of $273 million and an asset beta of 0.59.  MMT’s debt beta is 0.23.

a) What is their equity beta?

b) Suppose they make a pure capital structure change, where their debt falls by $57 million and their equity increases by $57 million.  Making reasonable assumptions as necessary, what is their new asset beta and their new equity beta?

(15 points)

5) The following table shows how the values for debt beta, equity beta and asset beta for Tangential Trumpeteers Inc. change as you hold the assets of the firm fixed and increase its debt ratio.  Fill in the blanks.

       (10 points)