Financial Market Quiz #1 Instructor: Ray Patrick S.
Guangco, CPA
Coverage: Chapter 23, 24 and 25
PROBLEM SOLVING
INSTRUCTION: Answer the following problems below. SHOW YOUR SOLUTION. NO SOLUTION, NO POINTS.
Submission: You may submit online through this email [email protected] in .doc or .docx file entitled Financial Market Quiz #2 or you
may submit a hardcopy to my office.
Deadline: June 22, 2020, Monday 12:00 Noon
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. His stock portfolio with the
following allocation and betas is shown below:
Stock Investment Beta
GMA7 20% 1.50
PCOR 25% (0.50)
BPI 30% 1.25
TEL 15% 0.75
PX 10% 1.000
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? __________ (2 points)
2. What is the portfolio required rate of return? ___________ (2 points)
3. If the entire P2,500,000 is invested in GMA7, what is the expected rate of return? __________ (2 points)
4. If P1,500,000 is invested in GMA7 and P1,000,000 is invested in PCOR, what is the expected rate of return? ___________ (2 points)
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 points)
2. What is the required rate of return on MacDow’s stock? ____________ (2 points)
3. Which stock has higher risk? Higher return? ___________ (2 points)
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? __________ (2 points)
5. What is the required rate of return on MacDow’s stock? ___________ (2 points)
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? ___________ (2 points)
7. What is the required rate of return on MacDow’s stock? ___________ (2 points)
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:
Debt Ratio Projected EPS Projected Stock Price
20% P3.20 P35.00
30% 3.45 36.50
40% 3.75 36.25
50% 3.50 35.50
Assuming that the firm uses only debt and common equity,
1. What is LCG’s optimal capital structure? ___________ (2 points)
2. What debt ratio is the company’s WACC minimized? ___________ (2 points)
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? ___________ (2 points)
2. What is the intrinsic value of each bond if the required rate of return is 9 percent? ___________ (2 points)
3. Compare the price changes in the two bonds when the required rate of return change to 9 percent. (2 points)
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. (2 points)
Fin 2: Financial Market Page 1 of 2
Financial Market Quiz #1 Instructor: Ray Patrick S. Guangco, CPA
Coverage: Chapter 23, 24 and 25
b. The dividend growth rate is expected to decrease to 8.5 percent and to remain constant at that level. (2 points)
c. The dividend growth rate is expected to increase to 12.5 percent and to remain constant at that level. (2 points)
“Commit to the Lord whatever you do, and he will establish your plans.”
Proverbs 16:3
Fin 2: Financial Market Page 2 of 2
