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Question 1
R2D-Star is a technology startup firm that is confident about its prospects. The company plans to pay a dividend of \$5 per share at the end of the first year. It then promises its investors that its dividends will grow at a rate of 7% for the next 10 years after the end of the first year and at 5% after that.Suppose that you are given the additional information:risk-free rate = 1.25%, beta of stock = 0.8, expected market return = 12%.

(a) Apply the Capital Asset Pricing Model to compute a suitable discount rate for the
stock of R2D-Star.
(5 marks)
(b) Compute the value of the stock of R2D-Star.
(5 marks)
(c) If the investor thinks that the growth projection is too optimistic and the growth rates
need to be reduced to 5% for the next 10 years after the first year and 0% after that,
how would she value the stock now?
(10 marks)

Question 2
Mr Neo works in Jules Burns Bank as an asset manager and he manages an equity fund. His fund implements a focussed strategy and comprises 4 stocks. The expected returns of the 4 stocks in various scenarios are shown here:
Scenario Stock 1 Stock 2 Stock 3 Stock 4
1 14.3% 8.0% 2.0% 8.0%
2 18.2% 8.4% 7.5% 4.0%
3 16.7% 9.5% 9.4% 2.0%
4 15.0% 10.1% 12.4% ?1.0%
5 15.1% 9.1% 12.5% ?2.0%
6 11.0% 8.9% 11.4% 3.0%
7 6.5% 6.0% 8.5% 6.0%
8 9.6% 8.5% 8.2% 4.0%
9 9.8% 7.8% 7.8% 5.0%
10 11.3% 7.5% 6.9% 3.0%

Assuming that the probabilities of the scenarios occurring are all equal, answer the following questions:
(a) Calculate the expected return, variance and standard deviation for each stock.
(10 marks)
(b) Suppose Mr Neo’s portfolio has weights of 50%, 25%, 15% and 10% respectively for Stock 1, Stock 2, Stock 3 and Stock 4. Calculate the expected return, variance and expected return per unit risk for the portfolio.
(10 marks)