Question

BTS corporation has two investment plans A,B and expected to get $1200 of cash flow in 1 year. The investment plan A's β is 1.0 and plan b β is 1.5. If the risk-free interest rate is 10% and market risk premium is 10%, please answer the following question.

1. WHAT IS current value of investment plan A and B?

2. what is required rate of return and current value of BTS corporation ?

Answer 1

1. In a years time investment is expected to return $1200 as market risk premium is given which is expected market return minus risk free rate,

market risk prem.= expected return of the market - R/f rate

10% = erm-10%

So, erm = 20%. As beta of plan A is 1, means it is expected to do as market does, means making market returns of 20%.

That implies 20% is the return of 1200 and investment amount is 6000 (planA)

Plan B has beta of 1.5, implies 30% movement, 1200 will be made on 4000 investment.

2. Required rate of return for plan A is = (10%+1*(20%-10%)) = 20%

Required rate of return for plan B is = (10%+1.5*(20%-10%))= 25%