If investors’ aversion to risk increased, would the risk premium on a high-beta stock increase by more or less than that on a low-beta stock? Explain.

W7 Assignment “Chapters 6 and 7”

QUESTIONS: 6-4, 6-5, 7-3

6-4

If investors’ aversion to risk increased, would the risk premium on a high-beta stock increase by more or less than that on a low-beta stock? Explain.

6-5

If a company’s beta were to double, would its expected return double?

7-3

Woidtke Manufacturing’s stock currently sells for $22 a share. The stock just paid a dividend of $1.20 a share (i.e., D0 = $1.20), and the dividend is expected to grow forever at a constant rate of 10% a year. What stock price is expected 1 year from now? What is the estimated required rate of return on Woidtke’s stock (assume the market is in equilibrium with the required return equal to the expected return)?

PROBLEMS: 6-3, 6-5, 7-4, 7-9

6-3

Suppose that the risk-free rate is 5% and that the market risk premium is 7%. What is the required return on (1) the market, (2) a stock with a beta of 1.0, and (3) a stock with a beta of 1.7? Assume that the risk-free rate is 5% and that the market risk premium is 7%.

6-5

A stock’s return has the following distribution:

Demand for the                                               Probability of This                                      Rate of Return If This

Company’s Products                                       Demand Occurring                                     Demand Occurs (%)

____________________________________________________________________________________

Weak                                                                        0.1                                                          ?50%

Below average                                                       0.2                                                           ?5

Average 0.4 16

Above average                                                       0.2                                                            25

Strong                                                                      0.1                                                            60

1.0

7-4

Nick’s Enchiladas Incorporated has preferred stock outstanding that pays a dividend of $5 at the end of each year. The preferred sells for $50 a share. What is the stock’s required rate of return (assume the market is in equilibrium with the required return equal to the expected return)?

7-9

Crisp Cookware’s common stock is expected to pay a dividend of $3 a share at the end of this year (D1 = $3.00); its beta is 0.8; the risk-free rate is 5.2%; and the market risk premium is 6%. The dividend is expected to grow at some constant rate g, and the stock currently sells for $40 a share. Assuming the market is in equilibrium, what does the market believe will be the stock’s price at the end of 3 years (i.e., what is P3 ^)?