Discussion Post
• Describe how adding a risk-free security to modern portfolio theory allows investors to do better than the efficient frontier.
• Describe how different allocations between the risk-free security and the market portfolio can achieve any level of market risk desired. Give examples of a portfolio from a person who is very risk averse and a portfolio for someone who is not so averse to taking risk.
• Explain how the concept of a positive risk-return relationship breaks down if you can systematically find stocks that are overvalued and undervalued.
• If stock prices are not strong-form efficient, what might be the price reaction to a firm announcing a stock buyback? Explain.
• Under what situations would you want to use the CAPM approach for estimating the component cost of equity? The constant-growth model?
• Could you calculate the component cost of equity for a stock with nonconstant expected growth rates in dividends if you didn't have the information necessary to compute the component cost using the CAPM? Why or why not?
• Suppose your firm wanted to expand into a new line of business quickly, and that management anticipated that the new line of business would constitute over 80 percent of your firm's operations within three years. If the expansion was going to be financed partially with debt, would it still make sense to use the firm's existing cost of debt, or should you compute a new rate of return for debt based on the new line of business?
• Explain why the divisional cost of capital approach may cause problems if new projects are assigned to the wrong division.
The response must include a reference list. Using Times New Roman 12 pnt font, double-space, one-inch margins, and APA style of writing and citations.