Question

1. Problem 6-10

Portfolio Required Return

Suppose you manage a $3.8 million fund that consists of four stocks with the following investments:

Stock Investment Beta

A $200,000 1.50

B 550,000 -0.50

C 900,000 1.25

D 2,150,000 0.75

If the market's required rate of return is 9% and the risk-free rate is 5%, what is the fund's required rate of return? Do not round intermediate calculations. Round your answer to two decimal places. %

2. Problem 9-2
After-Tax Cost of Debt

LL Incorporated's currently outstanding 7% coupon bonds have a yield to maturity of 12%. LL believes it could issue new bonds at par that would provide a similar yield to maturity. If its marginal tax rate is 30%, what is LL's after-tax cost of debt? Round your answer to two decimal places.

%

3. Problem 9-4
Cost of Preferred Stock with Flotation Costs

Burnwood Tech plans to issue some $60 par preferred stock with a 8% dividend. A similar stock is selling on the market for $65. Burnwood must pay flotation costs of 6% of the issue price. What is the cost of the preferred stock? Round your answer to two decimal places.

%

Please, show step by step. Thank you.

Answer 1

Solution to Problem 6-10

Beta of the portfolio

Stocks	Amount invested ($)	Weight to total value [Amount invested / Total value]	Beta of the stock	Overall Beta [Beta of the stock x Weight to total value]
A	200,000	0.0526	1.50	0.08
B	550,000	0.1447	-0.50	-0.07
C	900,000	0.2368	1.25	0.30
D	2,150,000	0.5658	0.75	0.42
TOTAL	3,800,000	1.0000		0.73

As per Capital Asset Pricing Model [CAPM], the Required Rate of Return is calculated by using the following equation

Required Rate of Return = Risk-free Rate + Beta(Market Rate of Return – Risk-free Rate)

= Rf + B[Rm – Rf]

= 5.00% + 0.73[9.00% - 5.00%]

= 5.00% + [0.73 x 4.00%]

= 5.00% + 2.92%

= 7.92%

“Hence, the fund's required rate of return will be 7.92%”