Part 1
Please pay attention to the pattern of returns for three asset classes stocks, bills, and bonds.

1. Can you explain why returns are all positive for T-bills 1928-2011?

2. Returns are positive/negative for stocks and bonds, although most positive than negative. What percentage of time stocks returns are positive in the span of 1928-2011?

3. Suppose you plan to hold the stocks in in your retirement account (401K included) for 30 plus years. Is the risk in stocks relevant and material?

Part 2

1. Determine what level of market efficiency each event is consistent with:
* Immediately after an earnings announcement the stock price jumps and then stays at the new level.
* The CEO buys 50,000 shares of his company and the stock price does not change.
* An investor analyzes company quarterly and annual balance sheets and income statements looking for undervalued stocks. The investor earns about the same return as the S&P 500 Index.

2. Risk PremiumThe average annual return on the S&P 500 Index from 1986 to 1995 was 15.8 percent. The average annual T-bonds yield during the same period was 7.6 percent. What was the market risk premium during these ten years?

3. CAPM Required ReturnHastings Entertainment has a beta of 0.44. If the market return is expected to be 12 percent and the risk-free rate is 4 percent, what is Hastings’ required return?

4. Expected Return Risk
Determine the standard deviation of the expected return (Economic State, Probability, Return)
Fast growth 0.2 40%
Slow growth 0.4 10%
Recession 0.4 −25%

5. Portfolio Beta You own $15,000 of Olympic Steel stock that has a beta of 2.1. You also own $35,000 of Rent-a-Center (beta = 1.2) and $10,000 of Lincoln Educational (beta = 0.7). What is the beta of your portfolio?

Part 3

1. Under what situations would you want to use the CAPM approach for estimating the component cost of equity? The constant-growth model?
2. Cost of Equity JaiLai Cos. stock has a beta of 1.2, the current risk-free rate is 4.2 percent, and the expected return on the market is 12 percent. What is JaiLai’s cost of equity?
3. Cost of Debt KatyDid Clothes has a $250 million (face value) 30-year bond issue selling for 103 percent of par that carries a coupon rate of 7.95 percent, paid semiannually. What would be Katydid’s before-tax component cost of debt?
4. Cost of Preferred Stock Marme, Inc. has preferred stock selling for 97.5 percent of par that pays an 8 percent annual coupon. What would be Marme’s component cost of preferred?
5. WACC Suppose that JB Cos. has a capital structure of 75 percent equity, 25 percent debt, and that its before-tax cost of debt is 9 percent while its cost of equity is 15 percent. If the appropriate weighted average tax rate is 30 percent, what will be JB’s WACC?

Part 4

1. Payback Compute the payback statistic for Project with the following cash flows:
Time 0 1 2 3 4
Cash flow -150,000 60000 60000 70000 100000
Deciding whether the firm should accept or reject the project with the cash flows shown above if the appropriate cost of capital is 8 percent and the maximum allowable payback is three years.

2. Discounted Payback Compute the discounted payback statistic for Project in the above example and recommend whether the firm should accept or reject the project with the cash flows shown above if the appropriate cost of capital is 10 percent and the maximum allowable discounted payback is three years.
3. IRR Compute the IRR statistic for project in problem 1and note whether the firm should accept or reject the project with the cash flows shown above if the appropriate cost of capital is 7.5 percent.
4. PI Compute the PI statistic for Project in problem 1 and advise the firm whether to accept or reject the project if the appropriate cost of capital is 8 percent.

Part 1 Please pay attention to the pattern of returns for three as...