Assignment 2: The Capital Asset Pricing Model
You are considering an investment in Concordia Utilities and have some questions regarding the income generating abilities of the company.
Concordia Utilities has 4 plants in four states and they all operate as separate entities. All four plants are financed by Concordia and have no holdings of their own, but operate as if they were separate companies. You have gathered some information about the company’s plants as follows:
Table-1:
Plant |
Beta Coefficient |
% of Concordia’s Income |
South Town |
0.85 |
55% |
North Town |
0.90 |
20% |
East Town |
1.25 |
15% |
West Town |
1.60 |
10% |
You have also gathered some information about the market and found that the risk-free rate of interest is 3% and that the company adds a market risk premium of 4% to all investments. The possible market returns and their probabilities are found in Table-2:
Table-2:
Probability |
Return |
0.15 |
8% |
0.2 |
9% |
0.5 |
10% |
0.1 |
11% |
0.05 |
12% |
Questions:
- What is the Beta coefficient for Concordia? Explain your answers.
- What is Concordia’s required rate of return on any new investments? Explain your answers.
- What is the equation for the Security Market Line (SML)? Show the equation and graph the equation on a graph. Explain what the SML is telling you, and the implications for the firm.
- Suppose Concordia has the opportunity to purchase an additional plant. The cost of the new plant will be $200 million and have a beta coefficient of 1.60. If the new plant is expected to return 12%, should Concordia make the investment? Explain your answers and justify your calculations.
Present your analysis of the assigned problems in Excel format. Enter non-numerical responses in the same worksheet using textboxes.
Assignment 2 Grading Criteria |
Maximum Points |
Correctly calculated the beta coefficient for the company and explained its meaning and significance to the firm. |
20 |
Correctly calculated the Concordia’s required rate of return on any new investments and explained the significance of this number to the investing activities of the firm. |
20 |
Correctly determined the function for the SML and plotted this function, graphically. |
16 |
Explained the significance of the SML in terms of the information it provides and the significance to the firm and in terms of future investments. |
16 |
Correctly evaluated the new investment and made a recommendation as to whether the investment should go forward, explaining the rationale. |
16 |
Used correct spelling, grammar, and punctuation and followed APA style guidelines. |
12 |
Total: |
100 |