Synna V.

Fabria June 22, 2020

BSA – II

PROBLEM 1 (Capital Asset Pricing Model)

Mr. Lucky Mi won P5, 000,000 from lottery of PCSO. He invested 40% of his winnings in bonds and 50%
in stocks. The market’s required rate of return is 10% and the risk-free rate is 6%.

Questions:

1. What is the beta portfolio in his stock investments?

5,000,000*50% = 2,500,000

2,500,000*20%=500,000/2,500,000*1.50= 0.30

2,500,000*25%=625,000/2,500,000*(0.50) = (0.125)

2,500,000*30%=750,000/2,500,000*1.25= 0.375

2,500,000*15%=375,000/2,500,000*0.75= 0.1125

2,500,000*10%=250,000/2,500,000*1.000= 0.10___

0.7625

2. What is the portfolio required rate of return?

6% + (10% - 6%) 0.7625 = 0.0905/ 9.05%

3. If the entire P2, 500,000 is invested in GMA7, what is the expected rate of return?

6% + (10% - 6%) 1.50 = 0.12 / 12%

4. If P1, 500,000 is invested in GMA7 and P1, 000,000 is invested in PCOR, what is the expected rate of
return?

1,500,000 / 2,500,000*1.50= 0.90

1,000,000 / 2,500,000*(0.50) = (0.20)

2,500,000 0.70
PROBLEM 2 (Security Market Line)

Jollivee Company’s stock has a beta of 1.5, while MacDow Company’s stock beta is 0.8. The real risk-free
rate is 2%, the inflation premium is 3% and the required rate of return on an average stock is 12%.

1. What is the required rate of return on Jollivee’s stock?

2% + (12% - 2%) 1.50 = 0.17 / 17%

2. What is the required rate of return on MacDow’s stock?

2% + (12% - 2%) 0.80 = 0.10 / 10%

3. Which stock has higher risk? Higher return?

The stock with the higher risk is Jollivee – 17%

If the expected rate of inflation rate increased to 3%, the real risk-free rate remains constant: (change in
SML due to inflation)

4. What is the required rate of return on Jollivee’s stock?

8% + (12% - 8%) 1.50 = 0.14 / 14%

5. What is the required rate of return on MacDow’s stock?

8% + (12% - 8%) 0.80 = 0.112 / 11.20%

If the required return on the market falls to 10.5%, and all betas remain constant: (change in SML due to
behavior)

6. What is the required rate of return on Jollivee’s stock?

5% + (10.5% - 5%) 1.50 = 0.1325 / 13.25%

7. What is the required rate of return on MacDow’s stock?

5% + (10.5% - 5%) 0.80 = 0.094 / 9.4%

PROBLEM 3 (Optimal Capital Structure)

LCG Distribution Company is in the process of setting its target capital structure. The CFO believes that
the optimal debt ratio is somewhere between 20% and 50%, and her staff has compiled the following
projections for EPS and the stock price at various debt levels.

Assuming that the firm uses only debt and common equity,

1. What is LCG’s optimal capital structure?

20% - 35P

30% - 36.50P

40% - 36.25P

50% - 35.50P

2. What debt ratio is the company’s WACC minimized?

- Terrell's stock price is maximized at the Debt/Capital Ratio of 30%. The debt level is also where
minimization of WACC at optimal capital structure occurs which is at 30% debt ratio.

PROBLEM 4

Meralco has two P1,000 par value bonds outstanding. Bond #1 matures in five years and Bond #2
matures in 15 years. Both bonds pay P80 interest annually and currently sell at their par value. Thus, the
current required rate of return is 8%.

1. Which bond should know the greater price change in response to an increase in the required rate of
return?

For Bond # 1:

(1,000 / 1.085) = 680.58

1−1.08−5
80 * = 319.42
0.08
1,000

For Bond # 2:

(1,000 / 1.0815) = 315.24

1−1.08−15
80 = 684.76
0.08
1,000
- The Bond which has greater price change in response to an increase in the required rate of return is
Bond # 2 due to a father maturity date.

2. What is the intrinsic value of each bond if the required rate of return is 9 percent?

For Bond # 1:

(1,000 / 1.095) = 649.93

1−1.09−5
80* = 311.17
0.09
961.10

For Bond # 2:

(1,000 / 1.0915) = 274.54

1−1.09−15
80* = 644.86
0.09
919.40

3. Compare the price changes in the two bonds when the required rate of return change to 9 percent.

For Bond # 1:

1,000 – 961.10 = 38.9

1,000 – 919.40 = 80.6

PROBLEM 5

Ordinary equity share dividends of Stark Industries have been growing at an annual rate of 10 percent.
The current dividend per share is P1.20. If an investor requires a 15 percent return on the share, what is
the current value of 100 shares of Stark Industries under each of the following conditions?

a. Dividends are expected to continue growing at a constant rate of 10 percent.

D(1) = D(0) * (1 + g)

(1.20 (1.10))/(0.15- 0.10) = 1.32/0.05 = 26.40

b. The dividend growth rate is expected to decrease to 8.5 percent and to remain constant at that level.

(1.20(1.085))/(0.15−0.085) = 20
c. The dividend growth rate is expected to increase to 12.5 percent and to remain constant at that level.

(1.20(1.125))/(0.15−0.125) = 54