a. Equity Risk Premium – the return that investors expect to receive above the return of the risk-free asset for investing into a risky asset. What does this mean?
b. How do we use the Expected Rate of Return from our investment to discount the expected cash flows from our investment to determine the present value (intrinsic value)? Please calculate the fair value of an investment with a dividend payout ratio of 40%, Next year’s dividend expectations of $2.40, growth rate of 3.0%, Risk-free rate is 2.4%, beta is 0.9 and ERP is 5.0%.
c. What is the difference between an Arithmetic Mean (Average) and a Geometric Mean (Average)? a. Why should investors know the difference?
d. Describe why a person must take risk to gain the potential for a higher return than they would receive for investing into the risk-free asset?
e. Be prepared to discuss which investment a reasonable person would choose to invest into over the next 5 years and why? a. Investment A has a mean return of 6% and a standard deviation of 12%. b. Investment B has a mean return of 5% and a standard deviation of 9%.