Part A) You have been managing a $5 million portfolio that has a beta of 1.25 and a required rate of return of 8.875%. The current risk-free rate is 2%. Assume that you receive another $500,000. If you invest the money in a stock with a beta of 1.45, what will be the required return on your $5.5 million portfolio? Do not round intermediate calculations. Round your answer to two decimal places.
Part B) Carnes Cosmetics Co.'s stock price is $54, and it recently paid a $2.50 dividend. This dividend is expected to grow by 25% for the next 3 years, then grow forever at a constant rate, g; and rs = 15%. At what constant rate is the stock expected to grow after Year 3? Do not round intermediate calculations. Round your answer to two decimal places.
1.
Calculating Market Rate by using CAPM model,
0.08875 = 0.02 + 1.25(Rm - 0.02)
Rm = 7.50%
New Beta = [5,000,000(1.25) + 500,000(1.45)]/5500,000
New Beta = 1.268
Required Return = 0.02 + 1.268(0.075 - 0.02)
Required Return = 8.97%
2.
54 = 2.50(1.25/1.15) + 2.50(1.25/1.15)2 + 2.50(1.25/1.15)3 + X/(1.15)3
54 = 2.72 + 2.95 + 3.21 + X/(1.15)3
X = $68.79
So,
68.79 = 2.50(1.25)3(1 + g)/(0.15 - g)
14.10(0.15 - g) = (1 + g)
2.115 - 14.10g = 1 + g
g = 7.38%
Part A) You have been managing a $5 million portfolio that has a beta of 1.25...
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