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Homework answers / question archive / Suppose you have the following possible risky investments (A,B,C,D) and a risk free investment (RF) where the states have equal probability of occurring: Investment State 1 State 2 State 3 State 4 A -3 -2 8 8 B 1 9 8 -2 2

Suppose you have the following possible risky investments (A,B,C,D) and a risk free investment (RF) where the states have equal probability of occurring: Investment State 1 State 2 State 3 State 4 A -3 -2 8 8 B 1 9 8 -2 2.25 C 0.75 1.25 0.75 D 3 6 16 1 -8 RF 1 1 1 1 Determine the expected return; variance, and standard deviation for each investment. Determine the Sharpe ratios for each risky investment (A,B,C,D). Determine the covariance, correlation coefficient, and Beta (slope) between investment A and each of the other investments. Suppose you are forming 4 equal weighted portfolios with A (A+B, A+, A+, A+RF). Report the Sharpe ratio of each portfolio. The table below reports the historic returns of various asset classes and firm Betas: Equity T-Bonds T-Bills Corporate Debt 896 Firm 1 Beta 0.7 Firm 2 Beta 1 Firm 3 Beta 1.5 11% 7% 596 Suppose each firm is taking on a project that has an expected life of 1 year. Determine the equity cost of capital for each firm. Now suppose a firm is taking on a project that has an expected life of 15 years, Determine the equity cost of capital for each firm. Suppose your firm has total assets of $1, a book value of stock of $.75, and a book value of debt of $.25. The yield to maturity on your bonds outstanding is currently 7%. The beta of your firm with the market is 1.25. The current risk-free rate is 3%, and you estimate the market risk premium to be 6%. What is your firm's cost of debt? What is your firm's weight of debt in the capital structure? What is your firm's cost of equity? What is your firm's weight of equity in the capital structure? What is your firm's weighted average cost of capital? Suppose your firm has a cost of debt of 6% and a debt to equity ratio of 2:1. Your firm's Beta is 1.8, the current 5-year Treasury Yield is 4%, and you estimate that the equity risk premium is 4%. You are considering a five-year project that has the following cashflows and default probabilities: 5 4 Year 3 0 1 2 100 50 0 -100 20 CF Pr(Default) 75 0.2 0.3 0 0 0.2 0.1 What is the weighted average cost of capital (WACC) for your firm? What is the NPV of the project assuming no default risk? What is the IRR of the project assuming no default risk? What is the NPV of the project with default risk? What is the IRR of the project assuming default risk? Rocket Co. just paid a dividend of $2.18. You anticipate that Rocket Co. will grow at an annual rate of 9% over the next 3 years due to the demand for their solid and liquid rocket boosters used by the Kerbal Space Program. Beginning 4 years from now, you anticipate the that public interest in the space program will fall and the growth of Rocket Co. will slow down to the average growth rate of the Kermin economy, which is 3%. The current risk-free rate in the Kermin economy is 5%, the market risk premium is 6%, and the Beta of Rocket Co. is 1.2. Using the CAPM model and the discounted cash flow approach to valuation to value Rocket Co.