Question

You are considering an investment in software company. The beta of software companies is 1.5. The...

  1. You are considering an investment in software company. The beta of software companies is 1.5. The annual risk-free rate is 2% and the annual market premium is 8%. The expected annual profit from the software subscription is $100,000 and it is expected to grow at the rate of 6% per year. What is the maximum price you are willing to pay for the company?

    A.

    $1,250,000.00
    B.

    $1,123,221.12
    C.

    $1,370,925.78
    D.

    $908,153.55
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Answer #1

As per CAPM,

Rf = Risk free Return = 2%                                                    

Rmp = Market Risk Premium= 8%

Beta = 1.5

Required Return = 2% +1.5(8%)

= 14%

So, Required rate of return(Ke) = 14%

Calculating the Maximum Price willing to pay for the company:

Price = Expected Annual Profit/(Ke-g)

= $1,00,00/(0.14-0.06)

= $1250,000

So, the maximum price you are willing to pay for the company is $1250,000

Option A

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