Q) The risk-free rate in a given economy is 5%, and the expected rate of return on the

market is 10%. I am buying a firm with a perpetual annual cash flow of Rs. 2,000. If I
think the beta of the firm is 0.8, when the beta is in fact 1.6, how much more will I offer
for the firm than it is really worth? (10 points)

Ans
Rf = 5%
Market return = 10 %
Beta =0.8
Expected return - 5% + 0.8[10% - 5%] = 9%.
Therefore, present value of perpetual annuity
= 2,000 / 0.09 =Rs 22,222.22
 
At Beta =1.6
Expected return - 5% + 1.6[10% - 5%] =13%.
Therefore, present value of perpetual annuity
2,000 / .13 = Rs 15,384.62

Extra amount - 22,222.22 - 15,384.62 = Rs 6,837.60

I will offer the firm an extra amount of Rs 6,837.60