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Consider a risky portfolio. The end-of-year cash flow derived from the portfolio will be either $12,000...

Consider a risky portfolio. The end-of-year cash flow derived from the portfolio will be either $12,000 or $38,000. The probability that the cash flow will be $12,000 is 40%. The alternative riskless investment in T-bills pays 3%. If you require a risk premium of 9%, how much will you be willing to pay for the portfolio?

A. $23585

B. $22321

C. $24643

D. $26038

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Homework Answers

Answer #1

Calculation of the amount you will be willing to pay for the portfolio:

Amount that you will be willing to pay will be equal to present value of expected cash flow.

Expected cash = $12,000 x 40% + 38,000 x 60%

= $4,800 + 22,800

= 27,600

Present value = Expected cash flow / (1+rate)^n

= $27,600 / (1 + 0.12)^1

= $27,600 / 1.12

= 24,642.86 or $24,643

So, the amount you will be willing to pay is $24,643. (Answer is C)

Note: Rate = Risk free rate + Risk premium

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