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Question
As financial manager of Material Supplies Inc., you have recently participated in an executive committee decision to enter into the plastics business. Much to your surprise, the price of the firm's common stock subsequently declined from $40 per share to $30 per share. While there have been several changes in financial markets during this period, you are anxious to determine how the market perceives the relevant risk of your firm. Assume that the market is in equilibrium. From the following data you find that the beta value associated with your firm has changed from an old beta of ____ to a new beta of ____.
(1) The real risk-free rate is 2 percent, but the inflation premium has increased from 4 percent to 6 percent.
(2) The expected growth rate has been re-evaluated by security analysts, and a 10.5 percent rate is considered to be more realistic than the previous 5 percent rate. This change had nothing to do with the move into plastics; it would have occurred anyway.
(3) The risk aversion attitude of the market has shifted somewhat, and now the market risk premium is 3 percent instead of 2 percent.
(4) The next dividend, D1, was expected to be $2 per share, assuming the "old" 5 percent growth rate.
a. 2.00; 1.50
b. 1.50; 3.00
c. 2.00; 3.17
d. 1.67; 2.00
e. 1.50; 1.67
Answer
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