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a. What is the estimated cost of common equity for the company? [4 marks]

b. What is the estimated after-tax cost of debt for the company? [4 marks]

c. What is the estimated cost of preferred equity for the company? [4 marks]

d. What is the estimated WACC of the company? [4 marks]

e. What is the implied long run growth rate of the company’s dividends? [4 marks]

Question 2. (20 marks) Your company is considering buying a new factory. The initial cost of the factory is $500,000, but there is an annual maintenance charge of $15,000. The factory will be depreciated over 25 years on a straight line basis (i.e. the depreciation rate each year). Your company plans to sell the factory in 3 years for $400,000. Use of the factory requires an increase in net working capital of $40,000. The 2

factory would increase net operating revenues by $200,000. The company’s marginal tax rate is 40 percent. Assume that all cash flows occur at the end of the respective year. a. What is the total year 0 cash flow? [4 marks]

b. What are the net operating cash flows in years 1, 2 and 3? [4 marks]

c. What is the terminal year cash flow? [4 marks]

d. If the project’s cost of capital is 10 percent, what is the NPV of the project? [4 marks]

e. What is the payback period of the project? [4 marks]

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Question 3. (20 marks) Consider two stocks, A and B, with the following expected returns and betas E(R) A B 9.55% 10.98% Beta 0.80 1.10

The risk free rate is 5.75% a. Assuming that Stock A is priced according to the CAPM, What is the market risk premium? [4 marks]

b. What is the equilibrium expected return of Stock B? [4 marks]

c. Consider Stock C, which has a beta of 0.90. Suppose that you have forecast a return of 8.00% for Stock C. Is Stock C is overpriced, underpriced or fairly priced? [4 marks]

d. Suppose that you construct an arbitrage portfolio to exploit any mispricing that you might have found in Stocks A, B and C. What would the weights of this portfolio be? [4 marks]

e. Suppose that the risk free rate rises by 1%. What is the equilibrium expected return of Stock A? [4 marks] 4

Question 4. (20 marks) Consider two stocks, A and B, with the following expected returns and standard deviations. E(R) A B 8.00% 12.00% Std. Dev. 20.00% 30.00%

The correlation coefficient between the returns of A and B is 0.3. Short selling is allowed. a. Consider a portfolio, P, that comprises 45% invested in stock A and 55% invested in stock B. What is the expected return, standard deviation and coefficient of variation of P? [4 marks]

b. Plot A and B in expected return-standard deviation space and draw (approximately) the feasible set for P. On this diagram, mark the minimum variance portfolio and the efficient set. [4 marks]...