Part b)
Step 1: Calculate Expected Return (CAPM) using Beta of .5 and 1
The expected return is calculated as below:
Expected Return with a Beta of .5 = Risk Free Rate + Beta*(Market Return - Risk Free Rate) = 6% + .5*(16% - 6%) = 11%
Expected Return with a Beta of 1 = Risk Free Rate + Beta*(Market Return - Risk Free Rate) = 6% + 1*(16% - 6%) = 16%
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Step 2: Calculate Current Stock Price at Different Expected Return Values
The current stock price at different expected return values is determined as follows:
Current Stock Price at Expected Return of 11% = Value of Perpetual Cash Flow/Expected Return = 1,000/11% = $9,091
Current Stock Price at Expected Return of 16% = Value of Perpetual Cash Flow/Expected Return = 1,000/16% = $6,250
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Step 3: Calculate Amount Overpaid
The amount that will be overpaid is arrived as below:
Amount Overpaid = Current Stock Price at Expected Return of 11% - Current Stock Price at Expected Return of 16% = 9,091 - 6,250 = $2,841 (answer)
how do you find (b) without knowing the risk free? 10:25 AM Mon Mar 30 123_Ch7quiz.pdf...
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