Part b:

Sorbond Industries has a beta of 1.45. The risk-free rate is 8 percent and the expected
return on the market portfolio is 13 percent. The company currently pays a dividend of
Rs.2 a share, and investors expect it to experience a growth in dividends of 10 percent per
annum for many years to come.
a. What is the stock’s required rate of return according to the CAPM?
b. What is the stock’s present market price per share, assuming this required return?
c. What would happen to the required return and to market price per share if the beta
were 0.80? (Assume that all else stays the same.)
Solution.
Sorbond Industries of beta = 1.45
Risk free rate = 8%
Expected return on the market = 13%
Dividend per share = Rs.2
Growth in dividend = 10% ( per annum)
a. What is the stock’s required rate of return according to the CAPM
Capital Asset Pricing Model =

Risk Free Rate + Beta ×( Expected market return−Risk Free Rate)

¿ 8 % +1.45× ( 13 %−8 % )
¿ 8 % +7.25 %
¿ 15.25 %
Rate of return according to CAPM = 15.25%

B.
What is the stock’s present market price per share, assuming this required return?
Under dividend discount model,
D
P=
(r−g)
P = price of the share
D = Dividend per share
D = rs2
r = required rate of return
r = 15.25%
g = growth rate
g= 10%
rs 2
Price of the share=
( 15.25 %−10 % )
¿ rs 38.10
Current market price per share = rs38.10

C.
What would happen to the required return and to market price per share if the beta were
0.80?
Required return using CAPM =

Risk Free Rate + Beta ×( Expected market return−Risk Free Rate)

¿ 8 % +0.80 × ( 13 %−8 % )
¿ 8 % +4 %
¿ 12 %

Therefore, required rate is 12% if the beta were 0.80

D
P=
(r−g)
rs2
Price of the share=
( 12 %−10 % )
Rs 2
¿
2%
¿ Rs 100
Present market price per share if beta is 0.80 = $100
Question No 4
Part a
Briarcliff Stove Company is considering a new product line to supplement its range line. It is
anticipated that the new product line will involve cash investment of Rs.700, 000 at time 0 and
Rs.1.0 million in year 1. After-tax cash inflows of Rs.250,000 are expected in year 2, Rs.300,000 in
year 3, Rs.350,000 in year 4, and Rs.400,000 each year thereafter through year 10. Though the
product line might be viable after year 10, the company prefers to be conservative and end all
calculations at that time.
a. If the required rate of return is 15 percent, what is the net present value of the project? Is it
acceptable?
b. What is the project’s payback period?
Solution
A)

Required data;

NCF 0=700,000

NCF 1=100,000

NCF 2=250,000

NCF 3=300,000

NCF 4 =350,000

NCF 5=400,000

NCF 6=400,000

NCF 7=400,000

NCF 8=400,000

NCF 9=400,000

NCF 10=400,000
Formula
NPV 1 NPV 10
NPV =NCF 0+ 1
+, , , , , ,, , , , , , ,, , , , , , , ,, ,+ 10
(1+ k ) (1+ k)
700,000 250,000 300,000 350,000 400,000 400,000 400,000 400,000
NPV =700,000+ + + + + + + + +
(1+0.15) (1+0.15) (1+ 0.15) (1+0.15) (1+ 0.15) (1+0.15) (1+ 0.15) (1+0.15)8
1 2 3 4 5 6 7

N PV =700,000+869565.21+189035.91+ 197254.86+200113.63+198870.69+172931.03+150370.81+13060.70

NPV =343339.54
b.

The project’s payback period

Initial investment =¿?
Initial investment =(700,000+1000,000)
¿ 170,0000
Formula
Initial investment
payback period=
cash flow
1700000
¿
400000
=4.25

payback period = 4.25