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18 Mar 2018

8. Prepare the following problems in Excel and ensure the formulas are present in the appropriate cells:

As an equity analyst you are concerned with what will happen to the required return to Universal Toddler Industries’ stock as market conditions change. Suppose rRF=5%, rM= 12%, and bUTI = 1.4

a) Under current conditions, what is rUTI, the required rate of return on UTI stock?

b) Now suppose rRF (1) increases to 6% or (2) decreases to 4%. The slope of the SML remains constant. How would this affect rM and rUTI?

c) Now assume rRF remains at 5% but rM (1) increases to 14% or (2) falls to 11%. The slope of the SML doesn’t remain constant. How would these affect rUTI?

Answer: a) ri = 14.8%

b) (1) rM= 13%, ri=15.8%

(2) rM= 11%, ri=13.8%

c) (1) ri = 17.6%

(2) ri = 13.4%

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Beverley Smith
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18 Mar 2018

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You, as the equity analyst, are concerned with what will happen to the required return to Toad Corporation's stock as market conditions change. Suppose rRF = 5%, rM = 9%, and bUTI = 1.8.

What is rUTI, the required rate of return on UTI Stock? Round your answer to two decimal places.

Now suppose rRF increases to 6%. The slope of the SML remains constant. How would this affect rM and rUTI? Select One from below:

I. Both rM and rUTI will increase by 1%.
II. rM will remain the same and rUTI will increase by 1%.
III. rM will increase by 1% and rUTI will remain the same.
IV. Both rM and rUTI will decrease by 1%.
V. Both rM and rUTI will remain the same.

Suppose rRF decreases to 4%. The slope of the SML remains constant. How would this affect rM and rUTI? Select one from below:

I. rM will decrease by 1% and rUTI will remain the same.
II. rM will remain the same and rUTI will decrease by 1%.
III. Both rM and rUTI will increase by 1%.
IV. Both rM and rUTI will remain the same.
V. Both rM and rUTI will decrease by 1%

Now assume rRF remains at 5% but rM increases to 11%. The slope of the SML does not remain constant. How would these changes affect rUTI? Select One from below:

I. rUTI will decrease by 3.6%.
II. rUTI will remain the same.
III. rUTI will increase by 3.6%.

Assume rRF remains at 5% but rM falls 8%. The slope of the SML does not remain constant. How would these changes affect rUTI? Select One from below:

I. rUTI will remain the same.
II. rUTI will decrease by 1.8%.
III. rUTI will increase by 1.8%.

Use the letter in front of the statement to answer the questions that follow.

Read all the options first. The letter may be used to answer more than one question.

A. It increases by 3%

B. It decreases by 3%

C. It increases, but not proportionately

D. It decreases, but not proportionately

E. No change, remains the same

F. The SML shifts upward, but the slope remains constant

G. The SML shifts downward, but the slope remains constant

H. The SML pivots upward, and the slope becomes steeper

I. The SML pivots downward, and the slope becomes flatter

ASSUME THAT INFLATION IS EXPECTED TO INCREASE BY 3% THIS YEAR.

1. ___What would happen to the risk free rate, rrf

2. ___What would happen to the market rate, rm

3. ___What would happen to the required rate, r

4. ___What would happen to the slope of the SML

NOW ASSUME THAT INFLATION WIL NOT INCREASE, BUT INVESTORS BECOME MORE AVERSE TO RISK, THUS REQUIRING AN ADDITIONAL 3% RETURN ON THEIR INVESTMENTS.

5. ___What would happen to the risk free rate, rrf

6. ___What would happen to the market rate, rm

7. ___What would happen to the required rate, r

8. ___What would happen to the slope of the SML

There are three investment opportunities to consider. The forecasted risk-free rate is 9%, and the expected market rate is 13%. What is the required rate of return, r, for each of the following scenarios. Show Work. Assume investment A has a beta of .8 Assume investment B has a beta of 1.5 Assume investment C has a beta of 2.0 Which is the least risky investment? ____ Which is the most risky investment? __

The risk-free rate of return, rRF, is 11%; the required rate of return on the market, rM, is 15%; and Schuler Company's stock has a beta coefficient of 1.5.

a. If the dividend expected during the coming year, D1, is $2.25, and if g is a constant 2%, then at what price should Schuler's stock sell? Round your answer to the nearest cent.
$

b. Now, suppose the Federal Reserve Board increases the money supply, causing a fall in the risk-free rate to 2% and rM to 12%. How would this affect the price of the stock? Round your answer to the nearest cent.
$

c. In addition to the change in part b, suppose investors' risk aversion declines; this fact, combined with the decline in rRF, causes rM to fall to 11%. At what price would Schuler's stock sell? Round your answer to the nearest cent.
$

d. Suppose Schuler has a change in management. The new group institutes policies that increase the expected constant growth rate to 6%. Also, the new management stabilizes sales and profits, and thus causes the beta coefficient to decline from 1.5 to 0.9. Assume that rRF and rM are equal to the values in part c. After all these changes, what is Schuler's new equilibrium price? (Note: D1 goes to $2.34.) Round your answer to the nearest cent.
$

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