What is the expected market risk premium


Question 1: The risk-free rate is 7.6 percent. Potpourri Inc. stock has a beta of 1.7 and an expected return of 16.7 percent. Assume the capital-asset-pricing model holds.

1. What is the expected market risk premium?
2. Magnolia Industries stock has a beta of 0.8. What is the expected return on the Magnolia stock?
3. Suppose you have invested $10,000 in a combination of Potpourri and Magnolia stock. The beta of the portfolio is 1.07. How much did you invest in each stock? What is the expected return of the portfolio?     

Question 2: The Tuft Company is generating cash flow of $333,000 per year.  If they invest in a new press, they expect to increase their cash flow to $400,000 per year.  The cash outflow for the new press is $250,000; to accept or reject the investment they have to consider the

A) press cost of $250,000 and total cash flow of $400,000 per year.
B) press cost of $250,000 and incremental cash flow of  $67,000 per year.
C) current cash flow of $333,000 and the cost of $250,000

Question 3: What is the nominal rate of interest given a real rate of interest of 5.0% and an inflation rate of 7.0%? (express your answer with one significant figure)
          
Question 4: You have been asked to evaluate two pollution control devices.  The wet scrub costs $100 to set up and $50 per year to operate.  It must be completely replaced every 3 years, and it has no salvage value.  The dry scrub device costs $200 to set up and $30 per year to operate.  It lasts for  5 years and has no salvage value. Assuming pollution control equipment is replaced as it wears out, which method do you recommend if the cost of capital is 10%?  Determine the equivalent  annuity  cost (EAC) and show your decision by marking your choice.  All revenues are assumed  to be the same.

Question 5: ABC Inc. is considering the purchase of a $500,000 computer with an economic life of five years.  The computer will be depreciated fully over five years using the straight line method.

The market value of the computer is $100K in five years.  The computer will replace five office employees whose combined annual salaries are $120K. The machine will also lower the firms required net working capital (NWC) by $100K.  This amount of NWC will need to be replaced once the machine is sold.  Tc = 34%, discount rate is 12%.  Determine the NPV to see if it is worth it?

 

Yr-0

Yr-1

Yr-2

Yr-3

Yr-4

Yr-5

Annual salary savings

 

120,000

 

 

 

 

Depreciation

 

 

 

100,000

 

 

Pre-tax income

 

 

 

 

 

 

Taxes

 

6,800

 

 

 

 

Operating C/F

 

 

 

 

113,200

 

ΔNWC

 

 

 

 

 

-100,000

Investment

-500,000

 

 

 

 

66,000

Total C/F

 

 

113,200

 

 

 

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