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    Risk Free Rate + Beta× (Expected Market Return Risk Free Rate)

    Uploaded by

    Sadiya Sweeto
    The document provides information to calculate the required rate of return, current market price per share, and changes if the beta was lower, for a stock called Sorbond Industries. It then provides cash flow information to calculate the net present value and payback period for a new product line being considered by Briarcliff Stove Company. The required rate of return for Sorbond Industries is 15.25% based on its beta of 1.45. The current market price per share is Rs. 38.10. If the beta was 0.80 instead, the required rate of return would be 12% and the market price per share would be Rs. 100. The net present value of the new product line is Rs.

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    Risk Free Rate + Beta× (Expected Market Return Risk Free Rate)

    Uploaded by

    Sadiya Sweeto
    400 views4 pages
    The document provides information to calculate the required rate of return, current market price per share, and changes if the beta was lower, for a stock called Sorbond Industries. It then provides cash flow information to calculate the net present value and payback period for a new product line being considered by Briarcliff Stove Company. The required rate of return for Sorbond Industries is 15.25% based on its beta of 1.45. The current market price per share is Rs. 38.10. If the beta was 0.80 instead, the required rate of return would be 12% and the market price per share would be Rs. 100. The net present value of the new product line is Rs.

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    The document provides information to calculate the required rate of return, current market price per share, and changes if the beta was lower, for a stock called Sorbond Industries. It then provides cash flow information to calculate the net present value and payback period for a new product line being considered by Briarcliff Stove Company. The required rate of return for Sorbond Industries is 15.25% based on its beta of 1.45. The current market price per share is Rs. 38.10. If the beta was 0.80 instead, the required rate of return would be 12% and the market price per share would be Rs. 100. The net present value of the new product line is Rs.

    Copyright:

    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
    400 views4 pages

    Risk Free Rate + Beta× (Expected Market Return Risk Free Rate)

    Uploaded by

    Sadiya Sweeto
    The document provides information to calculate the required rate of return, current market price per share, and changes if the beta was lower, for a stock called Sorbond Industries. It then provides cash flow information to calculate the net present value and payback period for a new product line being considered by Briarcliff Stove Company. The required rate of return for Sorbond Industries is 15.25% based on its beta of 1.45. The current market price per share is Rs. 38.10. If the beta was 0.80 instead, the required rate of return would be 12% and the market price per share would be Rs. 100. The net present value of the new product line is Rs.

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    You are on page 1of 4

    Part b:

    Sorbond Industries has a beta of 1.45. The risk-free rate is 8 percent and the expected
    return on the market portfolio is 13 percent. The company currently pays a dividend of
    Rs.2 a share, and investors expect it to experience a growth in dividends of 10 percent per
    annum for many years to come.
    a. What is the stock’s required rate of return according to the CAPM?
    b. What is the stock’s present market price per share, assuming this required return?
    c. What would happen to the required return and to market price per share if the beta
    were 0.80? (Assume that all else stays the same.)
    Solution.
    Sorbond Industries of beta = 1.45
    Risk free rate = 8%
    Expected return on the market = 13%
    Dividend per share = Rs.2
    Growth in dividend = 10% ( per annum)
    a. What is the stock’s required rate of return according to the CAPM
    Capital Asset Pricing Model =

    Risk Free Rate + Beta ×( Expected market return−Risk Free Rate)


    ¿ 8 % +1.45× ( 13 %−8 % )
    ¿ 8 % +7.25 %
    ¿ 15.25 %
    Rate of return according to CAPM = 15.25%

    B.
    What is the stock’s present market price per share, assuming this required return?
    Under dividend discount model,
    D
    P=
    (r−g)
    P = price of the share
    D = Dividend per share
    D = rs2
    r = required rate of return
    r = 15.25%
    g = growth rate
    g= 10%
    rs 2
    Price of the share=
    ( 15.25 %−10 % )
    ¿ rs 38.10
    Current market price per share = rs38.10

    C.
    What would happen to the required return and to market price per share if the beta were
    0.80?
    Required return using CAPM =

    Risk Free Rate + Beta ×( Expected market return−Risk Free Rate)

    ¿ 8 % +0.80 × ( 13 %−8 % )
    ¿ 8 % +4 %
    ¿ 12 %

    Therefore, required rate is 12% if the beta were 0.80


    D
    P=
    (r−g)
    rs2
    Price of the share=
    ( 12 %−10 % )
    Rs 2
    ¿
    2%
    ¿ Rs 100
    Present market price per share if beta is 0.80 = $100
    Question No 4
    Part a
    Briarcliff Stove Company is considering a new product line to supplement its range line. It is
    anticipated that the new product line will involve cash investment of Rs.700, 000 at time 0 and
    Rs.1.0 million in year 1. After-tax cash inflows of Rs.250,000 are expected in year 2, Rs.300,000 in
    year 3, Rs.350,000 in year 4, and Rs.400,000 each year thereafter through year 10. Though the
    product line might be viable after year 10, the company prefers to be conservative and end all
    calculations at that time.
    a. If the required rate of return is 15 percent, what is the net present value of the project? Is it
    acceptable?
    b. What is the project’s payback period?
    Solution
    A)

    Required data;

    NCF 0=700,000

    NCF 1=100,000

    NCF 2=250,000

    NCF 3=300,000

    NCF 4 =350,000

    NCF 5=400,000

    NCF 6=400,000

    NCF 7=400,000

    NCF 8=400,000

    NCF 9=400,000

    NCF 10=400,000
    Formula
    NPV 1 NPV 10
    NPV =NCF 0+ 1
    +, , , , , ,, , , , , , ,, , , , , , , ,, ,+ 10
    (1+ k ) (1+ k)
    700,000 250,000 300,000 350,000 400,000 400,000 400,000 400,000
    NPV =700,000+ + + + + + + + +
    (1+0.15) (1+0.15) (1+ 0.15) (1+0.15) (1+ 0.15) (1+0.15) (1+ 0.15) (1+0.15)8
    1 2 3 4 5 6 7

    N PV =700,000+869565.21+189035.91+ 197254.86+200113.63+198870.69+172931.03+150370.81+13060.70

    NPV =343339.54
    b.

    The project’s payback period


    Initial investment =¿?
    Initial investment =(700,000+1000,000)
    ¿ 170,0000
    Formula
    Initial investment
    payback period=
    cash flow
    1700000
    ¿
    400000
    =4.25

    payback period = 4.25

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