Question

Miscellaneous on risk and return (a) Professor James is considering how to invest her savings. His dad suggested to invest 25% of his savings in the stock of Emerson Electric (EE), and to nvest 50% in treasury bills (TB) and finally the remaining in Starbucks (S). Given James's port folio allocation, what rate of return should he expect to receive on his investment? Memo: EE, TB and S are paying 8%, 4% and 12% respectively (b) Benjamin Corporation, a growing computer software developer, wishes to de- termine the required return on asset Z, which has a beta of 1.5. The risk-free rate of return is 7%; the return on the market portfolio of assets is 11 %. What is the CAPM yield of return? (c) Robins Gameroom wishes to determine the returns on two of its video ma chines, Conqueror and Demolition. Conqueror was purchased 1 year ago for $20,000 and currently has a market value of $21,500. During the year, it generated $800 worth of after-tax receipts. Demolition was purchased 4 years ago; its value in the year just completed declined from $12,000 to $11,800 During the year, it generated $1,700 of after-tax receipts.

Answer 1

(a)

expected return on portfolio =  $\sum_{}^{}$(weight of investment * return on investment)

expected return on portfolio = (25% * 8%) + (50% * 4%) + (25% * 12%) = 7%.

(b)

CAPM yield = risk free rate + (beta * (market return - risk free rate))

CAPM yield = 7% + (1.5 * (11% - 7%)) = 13%.

(c)

Return on machine = (after-tax receipt + change in value) / value 1 year ago.

Return on Conquerer = (800 + (21500 - 20000)) / 20000 = 11.5%.

Return on Demolition = (1700 + (11800 - 12000)) / 12000 = -12.5%.