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You are considering acquiring a firm that you believe can generate expected cash flows of $10,000 a year forever. However, you recognize that those cash flows are uncertain a. Suppose you believe that the beta of the firm is 0.4. How much is the firm worth if the risk-free rate is 4% and the expected rate of return on the market portfolio is 11%? (Do not round intermediate calculations. Round your answer to 2 decimal places.) Value of the firm b. By how much will you overvalue the firm if its beta is actually O.6? (Do not round intermediate calculations. Round your answer to 2 decimal places.) Overvaluation
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contexto38 contexto38

Today at 11:51 PM

The overvalue of the firm if its beta is actually 0.6 will be acquired by subtracting the value of rate of return from the firm's total worth.

A. The required rate of return (RRR) is the minimal return an investor would accept for owning a company's shares in exchange for a certain amount of risk. In corporate finance, the RRR is used to assess the profitability of potential investment projects.

To calculate the RRR effectively and maximize its usefulness, the investor must also account his or her cost of capital, the return on other competing investments, and inflation.

Required return = beta + risk-free rate (market rate-risk free rate)

=4+(11-4)*0.4

=6.8%

Consequently, the value of a company is equal to its annual cash flows times the needed rate of return.

=10,000/0.068 = $147058.82 (Approx.)

B. An actual return is the actual gain or loss experienced by an investor on an investment or in a portfolio. It is also known as the internal rate of return (IRR). It can have a significant impact on net worth.

The true return is what investors get from their investments. A mutual fund's disclosure statement, for example, may declare, "The securities of the Fund you invest in yield 5% each year, however the actual return will likely be different."

Analyzing the causes for the disparity between predicted and actual return numbers aids in understanding the impact of systematic (market) and idiosyncratic (manager/fund) risk factors in portfolio returns.

actual return = 4 + (11 – 4) * 0.6

=8.2%

Therefore, the firm's worth should be equal to 10,000 divided by 0.08

=$121951.22(Approx.)

Consequently, overvaluation = 147058.82 – 121951.22

=$25107.6(Approx.)

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