Suppose that Emily plans to use the Discounted Cash Flow (DCF) model combined with the Capital Asset Pricing Model (CAPM) to value a firm today that is expected to last for one year.Another analyst has estimated the probability distribution for the firm cash flows (in $millions) at the end of the year, which is illustrated below. The other analyst has also provided the following information:

beta of the cash flows = 0.5

one-year risk free return is 3%

one-year expected market risk premium = 4%

In case you forgot, the CAPM implies that diversified investors expect a return equal to what they can earn on risk free securities plus the beta times the expected market risk premium.

Transcribed Image Text:

Statistics > Net CF Pert 0.0 112.1 10.4% Minimum -50.00 84.6% 5.0% 0.010 Maximum 150.00 Mean 50.00 0.009 0.008 0.007 Mode 50.00 Median 50.00 Std Dev 37.80 Skewness 0.0000 Kurtosis 2.3333 0.006 Left X 0.0 0.005 @RISK Course Version University of South Carolina Left P 10.4% Right X 112.1 Right P 95.0% 0.004 Dif. X 112.15 0.003 Dif. P 84.6% 1% -28.87 0.002 2.5% -20.67 5% -12.15 0.001 10% -0.673 20% 15.32 0.000 -100 -50- 50 0 550 100 100 150 200 25% 21.89 30% 27.96 Statistics > Net CF Pert 0.0 112.1 10.4% Minimum -50.00 84.6% 5.0% 0.010 Maximum 150.00 Mean 50.00 0.009 0.008 0.007 Mode 50.00 Median 50.00 Std Dev 37.80 Skewness 0.0000 Kurtosis 2.3333 0.006 Left X 0.0 0.005 @RISK Course Version University of South Carolina Left P 10.4% Right X 112.1 Right P 95.0% 0.004 Dif. X 112.15 0.003 Dif. P 84.6% 1% -28.87 0.002 2.5% -20.67 5% -12.15 0.001 10% -0.673 20% 15.32 0.000 -100 -50- 50 0 550 100 100 150 200 25% 21.89 30% 27.96