Business Finance
UBFF2013 BUSINESS FINANCE
Question:
1.
(a)
Frodo Baggins has RM1,500 to invest. His investment counselor suggests an investment that pays no stated interest but will return RM2,000 at the end of 3 years. (i) (ii) What annual rate of return will Frodo earn with this investment? Frodo is considering another investment, of equal risk, that earns an annual return of 8%. Which investment should he make and why?
(b)
Samwise Gamgee was seriously injured in an industrial accident. He sued the responsible parties and was awarded a judgment of RM2,000,000. Today, he and his attorney are attending a settlement conference with the defendants. The defendants have made an initial offer of RM156,000 per year for 25 years. Samwise plans to counteroffer at RM255,000 per year for 25 years. Both the offer and the counteroffer have a present value of RM2,000,000. Assume both payments are at the end of each year. (i) (ii) (iii) What interest rate assumption have the defendants used in their offer (rounded to the nearest whole percent)? What interest rate assumption have Samwise and his lawyer used in their counteroffer (rounded to the nearest whole percent)? Samwise is willing to settle for an annuity that carries an interest rate assumption of 9%. What annual payment would be acceptable to him?
2.
Gandalf Enterprise must consider several investment projects, A through E using the capital asset pricing model (CAPM) and its graphical representation, the security market line (SML). Relevant information is presented in the following table. Item Risk-free asset Market portfolio Project A Project B Project C Project D Project E (a) (b) (c) Rate of return (9%) 9 14 Beta, b 0.00 1.00 1.50 0.75 2.00 0.00 -0.50
Calculate: (i) the required rate of return and (ii) the risk premium for each project, given its level of nondiversifiable risk. Use your findings in part (a) to draw the SML (required return relative to nondiversifiable risk). Discuss the relative
Question:
1.
(a)
Frodo Baggins has RM1,500 to invest. His investment counselor suggests an investment that pays no stated interest but will return RM2,000 at the end of 3 years. (i) (ii) What annual rate of return will Frodo earn with this investment? Frodo is considering another investment, of equal risk, that earns an annual return of 8%. Which investment should he make and why?
(b)
Samwise Gamgee was seriously injured in an industrial accident. He sued the responsible parties and was awarded a judgment of RM2,000,000. Today, he and his attorney are attending a settlement conference with the defendants. The defendants have made an initial offer of RM156,000 per year for 25 years. Samwise plans to counteroffer at RM255,000 per year for 25 years. Both the offer and the counteroffer have a present value of RM2,000,000. Assume both payments are at the end of each year. (i) (ii) (iii) What interest rate assumption have the defendants used in their offer (rounded to the nearest whole percent)? What interest rate assumption have Samwise and his lawyer used in their counteroffer (rounded to the nearest whole percent)? Samwise is willing to settle for an annuity that carries an interest rate assumption of 9%. What annual payment would be acceptable to him?
2.
Gandalf Enterprise must consider several investment projects, A through E using the capital asset pricing model (CAPM) and its graphical representation, the security market line (SML). Relevant information is presented in the following table. Item Risk-free asset Market portfolio Project A Project B Project C Project D Project E (a) (b) (c) Rate of return (9%) 9 14 Beta, b 0.00 1.00 1.50 0.75 2.00 0.00 -0.50
Calculate: (i) the required rate of return and (ii) the risk premium for each project, given its level of nondiversifiable risk. Use your findings in part (a) to draw the SML (required return relative to nondiversifiable risk). Discuss the relative