Assume that the risk-free rate of interest is 3% and the expected rate of return on the market is 15%. I am buying a firm with an expected perpetual cash flow of $2,000 but am unsure of its risk. If I think the beta of the firm is 0.8, when in fact the beta is really 1.6, how much more will I offer for the firm than it is truly worth

The correct solution is "$6,564.01". A further solution is given below.

Explanation:

The given values are:

beta,

= 1.6

market return,

= 15%

cash flow,

= $2,000

risk free rate of interest,

= 3%

Now,

The stock return will be:

=

=

=

The actual worth of the firm will be:

=

=

=

=

With 0.8 beta, the stock return will be:

=

=

=

So that I'm paying for the firm,

=

=

= ($)

Hence,

I'm paying,

=

= ($)

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