3)  (10 points) You are an investment fund manager who can allocate funds between two stocks or form a portfolio of these two stocks. Stock A has a Beta of 1.65 and Stock B has a Beta of 0.55. The market portfolio is expected to return 11.8% and the Tbill rate is 3.2%. 
a) What is the expected return on each stock?
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b) What is the expected return on a portfolio that consists of $37,500 invested in asset A and $62,500 invested in asset B?


c) What is the portfolio Beta of an asset with 30% of the funds invested in asset A and 70% invested in asset B?


d) A client of yours wants a portfolio that has an expected return of 9.5%. How much must be invested in asset A and how much in asset B to accomplish this?


e) Suppose that Stock A actually returns 15% and Stock B returns 9% what should be expect to happen to the prices and returns of Stock A and B? Which is underpriced and which one is overpriced?
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4)  (10 points) Your firm is considering a project that is considered average risk by your firm. Overall your firm’s Beta is 0.77, the expected market risk premium is 9.8%, and the risk free rate of return is 3.1%. Your firm also has 7.4% semiannual coupon bonds with 9 years until maturity currently selling for 108.50% of par value. The corporate tax rate is 35% and your firm has a D/E ratio of 1.25. 
a) What is the cost of equity?


b) What is the cost of debt?


c) What are the capital structure weights


d) What is this firm’s weighted average cost of capital?


e) When is it appropriate to use WACC?


f) Describe the Subjective approach to adjusting WACC


g) Describe the Pure Play approach to adjusting WACC  
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5)  (20 Points) Your firm has 1 million shares of common stock each selling for $68.50 and the par value of bonds issued is $50 million but the bonds are currently priced at 98.25% of par. The bonds are 14 year semiannual 6.2% coupon bonds. Your firm just paid a dividend of $2.12 per share and this is expected to increase by 8% each year. The tax rate is currently 30%. A project under consideration is expected to generate revenues of $1,000,000 per year over the next four years but requires an initial investment in fixed assets of $1.2 million and $150,000 invested in net working capital (which will be recovered). Revenues are expected to remain steady over the next four years and variable costs account for 54% of revenues. Fixed costs are anticipated to be $120,000 per year. The fixed asset has a useful life of four years and a salvage value of $200,000. Your firm will depreciate this asset using the straightline method. To finance this project’s initial costs your firm will need to issue new stocks and bonds. The flotation cost of equity is 8.4% and the flotation cost of debt is 6.1% 
a) What are the capital structure weights for this firm?


b) What is the cost of equity?


c) What is the cost of debt?


d) What is this firm’s WACC?


e) What is the weighted average flotation cost?


f) What is the initial costs including flotation costs?
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g) What are the Cash Flows from Assets each year for this project?


h) Using NPV analysis how much value is created or destroyed by this project? Should your company accept or reject this project? 
investment fund manager
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