(PSG) has a market capitalization (market value of equity) of INR 90 billion, INR 30 billion in debts debt beta is 0.2.

PSG's equity beta is 1.2. You are planning to start a sporting risk‐free interest to be 7% and market risk premium to be 9%. 100% equity financed.
estimated cost of capital Solution: First calculate asset beta for PSG. That would be asset beta for your business. Equity beta would be same as no debt financing, use this Asses Beta into CAPM. BA = (D/D+E)*BD +(E/E+D)*BE => BA= 0.95. COC = 7+0.95*9=15.55%.
Beta differs from volatility: True. B) The risk premium investors can earn by holding the market portfolio is the difference between the market portfolio's expected return and the risk‐ free interest rate: True. C) Stocks in cyclical industries, in which revenues tend
to vary greatly over the business cycle, are likely to be more sensitive to systematic risk and have higher betas than stocks in less sensitive industries: true. D) Returns to the market portfolio represent unsystematic shocks to the economy: False – Systematic
shocks.Variance of Portfolio: Consider a portfolio that consists of an equal investment in 10 firms. Variance of return each of the firm is 0.01 and covariance for each pair is 0.005. What is the variance of this portfolio? Portfolio Variance = (1/N)*Var avg + (1-
1/N)*Cov avg = 1/10*0.01 + (1‐1/10)*0.005 =0.0055.Expected Return and Std Dev of Portfolio For the stock Onion, the expected return is 8% and the standard deviation is 12%. For the stock Pyaaj, the expected return is 11% and the standard deviation is 15%.
Covariance between Onion and Pyaaj is 0.0108. What is the expected return and standard deviation of a portfolio that invests 30% in Onion and balance in Pyaaj. Expected Return = WaRa+ (1-Wa)Rb = = 0.30*8% + 0.70*11% = 10.1%: Var = W^2Var(Ra)+(1-
Wa)^2Var(Rb)+2Wa*(1-Wa)Cov(Ra,Rb) = (0.3^2)*(0.12^2)+(0.7^2)*(0.15^2) + 2*0.3*07*0.0108 = 0.0169; Std Dev = Sqrt(0.0169) = 12.98%.A company has an asset beta of 1.0. It's debt beta is zero, the ratio of the book value of its equity to the book value of its
assets is 0.50, and the ratio of the market value of its equity to the market value of its assets is 0.80. The company's equity beta is Solution: Market value of debt and equity are relevant. 𝛽D=0; E/(D+E)=0.8; D/E=0.2/0.8=1.25; 𝛽e=𝛽a(1+D/E) = (1)(1.25)=1.25
Which of the following are systematic risks and which are idiosyncratic? A) The risk that oil prices rise (S) B) The risk of a product liability lawsuit(I) C) The risk that the CEO is killed in a plane crash(I)
D) The risk the Reserve Bank of India will increase the interest rates(S)Suppose that the market portfolio is equally likely to increase by 26% or decrease by 4%. Risk‐
free rate is 6%. What is the expected return, according to CAPM, on an asset with a beta of 0.8? 𝐸 [𝑅i]=Rf+ 𝛽i(𝐸 [𝑅m]-𝑅f) ; 𝐸 [𝑅m] = 0.5(26%) + 0.5(‐4%) = 11%; 𝑅f=6% ;𝐸 [𝑅i]=6% + (0.8)(11% ‐ 6%) = 10%
As per CAPM equation, the expected return on the stock with beta of 0.8 is 10%There is a 60% chance that the market return will 15% next year and a 40% chance that it will be 5% next year. Risk‐free rate is 6%. If Quantum Solace has
beta is 1.18, what is its expected return next year? E[Rm]= (60% × 15%) + (40% × 5%) = 11%; E[Ri]= 6% + 1.18 × (11% − 6%)investment is equally likely to have a 20% return or a ‐5% return. The expected return, and
Var of this investment? E(Rx)=sum(P(s)*Rx(s))= 0.50(20%) + 0.50(‐5%) = 7.5% ; Var(Rx)=sum(P(s)*(Rx(s)-E(Rx))^2)= 0.50(0.20 − 0.075)^2 + .50(−0.05 − 0.075^)2 = 0.0156
The market portfolio tends to increase by 52% when the economy is strong and decline by 21% when weak. What is the beta of S firm whose return is 55% on average when the economy is strong and -
24% when is weak? What is the beta of a type F firm that bears only idiosyncratic, firm‐specific risk? βi = Cov(rm,ri )/Var(rm) When there are only possible states U and D, βi = (Ui ‐Di )/ (Um‐Dm) βS =(55%‐(-24%))/(55%‐(‐21%))= 79%/73% = 1.082;
The return of a type F firm has only firm‐specific risk, however, and so is not affected by the strength of the economy. Because it will have the same expected return, whether the economy is strong or weak, βF = 0%/72% = 0
IRR QuestionsThe IRR for the following cash flows is closest to: Y0=200 Y1=-1000 Y2=400 Y3=600 A) 10.25% B) 18.75% C) 35.50% D) 54.75% Solution:
B i.e. 18.75%. Trial and error. Calculate NPVs at each of the discount rate. IRR is the rate at which NPV is 0. NPV ~= 0 at discount rate of 18.75%
Suppose a firm has two mutually exclusive projects: the first lasts one year, and the second lasts 5 years. Project x: Y0=-100, Y5=200; project Y; Y0=-100, Y1=125; Assume that the cost of capital is 10%. What is the IRR of each
project? Which project will you choose as per the IRR rule? Which project will choose as per the NPV rule? Which decision is right? Solution: Project X ‐100+200/((1+IRR)^5)=0. So IRR = 14.87% NPV @ 10% = ‐100+200/((1.10)^5)= 24.18 Project Y ‐
100+125/(1+IRR) =0. So IRR = 25% NPV @ 10% = ‐100+125/(1.10) = 13.64 Both projects have positive NPV and have IRR > Cost of Capital IRR Rule: Pick Project Y NPV Rule: Pick Project X Conflict between NPV and IRR: always go with the NPV rule. So pick Project X
The internal rate of return rule can result in the wrong decision if the projects being compared have: A) differences in scale. B) differences in timing. C) differences in NPV. D) A and B are correct. Solution: D
IRR rule assumes that the cash flows from the project can be reinvested to earn the rate of return equal to the IRR. Due to this assumption, it can incorrectly rank projects that have differences in timing of the cash flows IRR rule also ignores the differences in scale.
Consider the following NPV profile. What is the IRR of this project? If the cost of capital is 20%, what does the IRR rule say? What does the NPV rule say? If the cost of capital is 30%, what does the IRR rule say? What does the NPV rule say?
From the NPV profile, we see that the project has two IRRs: IRR1=25% and IRR2=400%. If the cost of capital is 20%, IRR rule will say that both the IRRs are higher than the cost of
capital. So “Accept the project”. However, we see that NPV is negative at 20% discount rate. So NPV rule will say “Reject the project”. If cost of capital is 30%, IRR rule cannot make a decision because IRR1< Cost of Capital < IRR2. However, at 30% discount rate NP
V is positive. So NPV rule will say “Accept the project”
TVM
FV of a Single Sum Interest rate is 8% per year. If you investment 3.5 million now, what will be its value five years from now? Solution: FV = 3.5x(1.08)5 = 5.14 million
PV of a Single Sum Ms. Shobha wants to have INR 10 million when she retires in 20 years. Assuming a 12% per year return, how much lump sum she would need to invest today? Solution: Present Value = INR 10,000,000 / (1+12%)20= INR 1,036,668
EMI You have taken a loan of INR 500,000 loan of with 10% interest rate per year (APR = Stated rate = 10%). You will repay the loan over 30 years in equal instalments. Compute the value of each instalment if a) These are annual instalments and interest will be
compounded annually. b) These are monthly instalments and interest will be compounded monthly; 500,000 is the PV of an annuity. We need to calculate C the per period cash flow. Use the annuity formula. a) Annual instalments: 500,000 = C *(1/0.1-
1/(0.1*(1.1)^30))= 53,039.62 b) Monthly instalments: monthly interest rate = 10%/12 = 0.83333% number of periods = 30 ⅹ 12 = 360 ; 500,000 = C*(1/0.833-1/(0.833*(1.0833)^360));C= 4,387.86
PV of Annuity Due: At 8% annual rate of interest how much money do you need in your account on your 65th birthday in order to withdraw 300,000 on that and the following 19 birthdays? Solution: This stream of cash flows is called annuity due. In a regular
annuity the first cash flow comes one period later. In annuity due, the first cash flow comes right now . PV= 300K+300K*(1/0.08-1/(0.08)*(1.08)^20-1)= 3,181,079.76
Comparing Deals: Kangaroo Autos is offering an “interest‐free loan” to buy a new car of 500,000. You pay 50,000 down and then 15,000 a month for the next 30 months. Thus, you a pay a total of 500,000 over the next 30 months. Turtle Motors next door does
not offer an interest‐free loan but will give you a discount of 50,000 if you pay the entire price right now (i.e. 450,000 after the discount). If the prevailing interest rate is 10% a year ,which is the better deal? Solution Prevailing interest rate of 10%, compounded
monthly, is the opportunity cost. You need to calculate PV of each stream of payments and choose the deal that has the lower PV. Rmonthly = APR / 12 = 10% / 12= 0.83333% PV of Kangaroo Deal: 50,000 + 15,000{ [1 / .0083333] ‐
[1 / .0083333 (1.0083333)30] } = 446,705.65 PV of Turtle Deal: 450,000 Kangaroo Deal is better Comparing Interest Rates: Which would you prefer? A. An investment paying interest of 12% (APR) compounded annually. B. An investment paying interest of 11.7%
(APR) compounded semiannually. C. An investment paying interest of 11.5% (APR) compounded continuously. Will your answer change if instead of investment, these were interest rates charged by banks on a loan you were planning to take? Solution:
Calculate effective annual rates (EAR). A: EAR = FV ‐ 1 = (1 + 0.12^)1 ‐ 1 = 1.12 ‐ 1 = 12% B: EAR = FV ‐ 1 = (1 + 0.117/2)^2 = 1.1204 – 1 = 12.04% C: FVC = FV – 1 = (e^0.115) ‐ 1= 1.1219 – 1 = 12.20% When investing, you are earning the EAR. So higher the better.
So choice C. When borrowing, you are paying the EAR. So lower the better. So choice A. Saving for college: You expect that son will go to a college in the U.S. 18 years from now. Taking into account inflation, you estimate that you will need USD 70,000 each in
Year 18 and Year 19 and USD 75,000 each in Year 20 and Year 21 to support her during her years in college. Assume that you will make investments in USD and earn an interest of 4% p.a. You plan to invest equal amounts (in USD) for the next 17 years (Year 1 to
Year 17) so that you will have enough money for your daughter’s college. How much do you need to invest each year? PV (College Expenditure) = PV(Annuity for the next 17 years) PV(College Expenditure) = 70,000/(1.04^18)+70,000/(1.04^19)
75,000/(1.04^20)+75,000/(1.04^21) = 134,920.48 PV(Annuity) = use formula= 134,920.48 Annual Investment = C = USD 11,090.26NPV – Mutually Exclusive Projects: Chose one with largest NPV Growing forever business = First Year Cash Flow/(g-r) – Initial
Investment Law of One Price An Exchange‐
Traded Fund (ETF) is a security that represents a portfolio of individual stocks. Consider an ETF for which each share represents a portfolio of 3 shares of Infosys (INFY), 1 share of Mahindra and Mahindra (M&M), and 2 shares of Dabur India (DABUR). Suppose
the current stock prices of each individual stock are: INFY – 800, M&M – 600, DABUR – 400. a. What is the price per share of the ETF in a normal market? b.
If the ETF currently trades for 3,500, what arbitrage opportunity is available? What trades would you make? c. If the ETF currently trades for 4,000, what arbitrage opportunity is available? What trades would you make?
a. We can value the portfolio by summing the value of the securities in it: Price per share of ETF = 3 × 800 + 1× 600 + 2 × 400 = 3,800 b.
If the ETF currently trades for 3,500, an arbitrage opportunity is available. To take advantage of it, one should buy the ETF for 3,500, sell 3 shares of INFY, sell 1 share of M&M, and sell 2 shares of DABUR. Total profit for such transaction is 3,800– 3,500 = 300. c.
If the ETF trades for 4,000, an arbitrage opportunity is also available. To take advantage of it, one should sell the ETF for 4,000, buy 3 shares of INFY, buy 1 share of M&M, and buy 2 shares of DABUR. Total profit for such transaction is 4,000 – 3,800 = 200
Estimating Cash Flows : Elmdale Enterprises is deciding whether to expand its production facilities. Although long‐term cash flows are difficult to estimate, management has projected the following incremental numbers for the first two years (in millions of dollars):
a. What are the incremental earnings (unlevered net income) for this project for years 1 and 2? b. What are the free cash flows for this project for the first two years?
A) Incremental Earning: Y1: Sales+ Other Sales-COGS-Depr-SGnA = EBIT; Income Tax = EBIT*Tax; Unlevered Income= EBIT-Income Tax; 106.5-47.7-25.9=EBIT=32.9; Unlevered Income= 32.9(1-0.4)
= 19.7
B) FCF: Unlevered Income + Depr-Cap Exp-Increase in NWC = 19.7+25.9-29.1-3.1=13.4

Suppose you receive $ 200 at the end of each year for the next three years. a. If the interest rate is 7 % what is the present value of these cash flows?b. What is the future
value in three years of the present value you computed in (a)?c. Suppose you deposit the cash flows in a bank account that pays 7 %interest per year. What is the balance in the account at the end of each of the next three years
(after your deposit is made)? How does the final bank balance compare with your answer in (b)?Solution: sum Cn/(1+r)^n; where Cn is the cash flow at time n; PV= 200/1.07 + 200/(1.07)^2 + 200/(1.07)^3 = 524.86 b)FVn= PV*(1+r)^n =
524.86*(1.07)^3 = 642.98 C) Y1= 200, FV2= 200*(1.07) = 414; FV3= 414+200*(1.07); EQUAL
A rich relative has bequeathed you a growing perpetuity. The first payment will occur in one year and will be $2,000. Each year after that, you will receive a payment on the anniversary of the last payment that is 5% larger than
the last payment. This pattern of payments will go on forever. If the interest rate is 9 %per year, a. What is today's value of the bequest? b. What is the value of the bequest immediately after the first payment is made? Here; R=
9%, G=5%, Growing perpetuity: C/(r-g) = 2000/(9-5)%=50000. B) Y2 onwards; we have to calculate PV at Y1: Cash Flows = 2000*(1.05); So, PV = 2000*1.05/(R-G)
You are running a hot Internet company. Analysts predict that its earnings will grow at10% per year for the next five years. After that, as competition increases, earnings growth is expected to slow
to 4% per year and continue at that level forever. Your company has just announced earnings of $3 million. What is the present value of all future earnings if the interest rate is 7%? (Assume all cash
flows occur at the end of the year)
This problem consists of two parts: a growing annuity for 5 years, and a growing perpetuity after 5 years. First we find the PV of the growing annuity (GA):=(3*1.1)*(1-(1.1/1.07)^5)/(0.07-0.1)=16.31. The value at
date 5 of the growing perpetuity (GP) is:PV5=C/r-g; where C is the year 6 cash flow, r is the interest (discount rate), and g is the growth rate.; PV5=3*(1.1)^5*1.04/0.07-0.04= 167. PV(GP)= PV5/(1+r)^5= 167/1.07^5=119.42
You are thinking of purchasing a house. The house costs $200,000. You have $29,000 in cash that you can use as a down payment on the house, but you need to borrow the rest of the purchase price. The bank is offering a 30-
year mortgage that requires annual payments and has an interest rate of 9 %per year. What will your annual payment be if you sign up for this mortgage? Solution: C=PV/(1/r*(1-1/(1+r)^n)) = 16645; PV needed = 200000-29000 =
171000; C=16645
You are thinking about buying a piece of art that costs $10,000. The art dealer is proposing the following deal: He will lend you themoney, and you will repay the loan by making the same payment every two years for the next 16
years (i.e., a total of 8 payments). If the interest rate is 5 %per year, how much will you have to pay every two years? As you can see from the above timeline, this cash flow stream is an annuity that consists of 8 equal payments of C.
First, we need to calculate the two-year interest rate: the one-year rate is 5%, so by the second rule of time travel, $1 today will be worth (1.05)^2 = 1.1025 in two years, so the two-year interest rate is 0.1025, The calculation of the loan payment
is then found using the equation for an annuity payment(Same as before question): PV= 10000,r=10.25
An American Depositary Receipt (ADR) is security issued by a U.S. bank and traded on a U.S. stock exchange that represents a specific number of shares of a foreign stock. For example, Nokia Corporation trades as an ADR under the symbol
NOK on the NYSE. Each ADR represents one share of Nokia Corporation stock, which trades under the symbol NOK1V on the Helsinki stock exchange. If the U.S. ADR for Nokia is trading for $ 10.10 per share, and Nokia stock is trading on the
Helsinki exchange for euro 6.40 per share, use the Law of One Price to determine the current $/euro€ exchange rate. = 10.10/6.4 = $1.578 per Euro
Pisa Pizza,is introducing a healthier version of its. The firm expects that sales of the new pizza will be $22 million per year. While many of these sales will be to newcustomers, Pisa Pizza estimates that 38% will come from
customers who switch to the new, healthier pizza instead of buying the original version.a. Assume customers will spend the same amount on either version. What level of incremental sales is associated with introducing the
new pizza?b. Suppose that 37% of the customers who will switch from Pisa Pizza's original pizza to its healthier pizza will switch to another brand if Pisa Pizza does not introduce a healthier pizza. What level of incremental sales
is associated with introducing the new pizza in this case? A) Incremental Sales: Sales of new Pizza -Lost sales of original pizza = 22-(0.38*22) = 13.64; B) ) Incremental Sales: Sales of new Pizza -Lost sales of original pizza from customers
who would have not switched brands = 22-(1-0.37)*0.38*22 = 16.73