QUESTION TWO ( 2 )

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1. Merlo, Inc. maintains a debt-equity ratio of .40 and follows a residual dividend policy. The company has after-tax earnings of $1,600 for the year and needs $1,400 for new investments. What is the total amount Merlo will pay out in dividends this year? ( 3 Marks )

2. You recently purchased a stock that is expected to earn 12 % in a booming economy, 8 % in a normal economy and lose 5 % in a recessionary economy. There is a 15 % probability of a boom, a 75 % chance of a normal economy, and a 10 % chance of a recession. What is your expected rate of return on this stock? ( 3 Marks )

3. Shares are currently selling for $4.4625. At the beginning of the year you bought them for $4.25 and during the year a dividend of 21.25 cents per share was paid. What is the return? ( 3 Marks )

4. Which one of the following stocks is correctly priced if the risk-free rate of return is 2.5 percent and the market risk premium is 8 percent? ( 3 Marks )

STOCK	BETA	EXPECTED RETURN
A	.68	8.2%
B	1.42	13.9%
C	1.23	11.8%
D	1.31	12.6%
E	.94	9.7%

5. Using the following information, calculate the portfolio beta and expected return:

Event	Wealth Invested	Expected Return	Beta
A	K10,000	8%	.80
B	K20,000	12%	.95
C	K30,000	15%	1.10
D	K40,000	18%	1.40

( 3 Marks )