Answer:
a. 7.71%
b. $57.57
Explanation:
a. The computation of discount rate is shown below:-
Discount rate = Risk free rate of return + Market Risk Premium × Beta
Here Common stock will have the same market risk as S&P 500 i.e Beta of Common Stock is 1
= 1.5% + 7.6 × 1
= 7.71%
b. The computation of stock price is shown below:-
Stock price = Expected Stock Value at year End ÷ (1+ Discount rate) + Expected Dividend ÷ (1 + Discount Rate)
= $60 ÷ (1 + 7.71%) + $2 ÷ (1 + 7.71%)
= $60 ÷ 1.0771 + 2 ÷ 1.0771
= $55.71 + $1.86
= $57.57
Answer & Explanation:
Step 1
The expected rate of return r is calculated as follows:
r = (expected revenue - cost / cost) * 100%
= (550 - 500 / 500) * 100%
=10%
Step 2
The publisher will choose to invest the machine when the real interest rate is 10% and 9%. When the expected rate of return is higher than the cost of borrowing, that is, the real interest rate, the investment is profitable and should be undertaken.
In this question, the expected rate of return is 10%, higher than the borrowing cost of 8% and 9%; thus, the investment of the new machine should be undertaken.
When the cost of borrowing is 11%, which is higher than the rate of return of 10%, the investment should not be undertaken.
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