3. Suppose a large institutional investor Alliance's portfolio has a beta of 0.5. Another institutional...
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3. Suppose a large institutional investor Alliance's portfolio has a beta of 0.5. Another institutional investor Best's portfolio has an expected return of 10 percent and a standard deviation of 15 percent. Both portfolios have the same Sharpe ratio of 0.6, and the market portfolio can be described as a portfolio comprising these two with equal weights. Suppose there is a firm called Cunning corporation, whose stock's beta is 2 and it can borrow at the risk free rate. Cunning's equity value is 1 million and its debt is 1.5 million. The present value of Cunning's tax shield is 0.3 million. Assuming that both CAPM and the Modigliani-Miller theorem with corporate taxes hold, answer the following questions. a) What is the risk free rate? [5 marks b) What is the expected return on the market portfolio? [5 marks c) What is the after-tax WACC of Cunning? [10 marks Total 20 marks END OF PAPER
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