Homework Answers
Answer a.
Risk-free Rate = 4%
Beta = 0.40
Market Return = 11%
Required Return = Risk-free Rate + Beta * (Market Return -
Risk-free Rate)
Required Return = 4.00% + 0.40 * (11.00% - 4.00%)
Required Return = 6.80%
Value of Firm = Expected Cash Flows / Required Return
Value of Firm = $10,000 / 0.0680
Value of Firm = $147,058.82
Answer b.
Risk-free Rate = 4%
Beta = 0.60
Market Return = 11%
Required Return = Risk-free Rate + Beta * (Market Return -
Risk-free Rate)
Required Return = 4.00% + 0.60 * (11.00% - 4.00%)
Required Return = 8.20%
Value of Firm = Expected Cash Flows / Required Return
Value of Firm = $10,000 / 0.0820
Value of Firm = $121,951.22
So, value of firm is overvalued by $25,107.60 ($147,058.82 - $121,951.22)
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