1) Brown Cow Co. is famous for its chocolate milk production facilities. They already have a...

1) Brown Cow Co. is famous for its chocolate milk production facilities. They already have a major share of the chocolate milk market and they cannot expand their business in chocolate milk anymore. One of their geniuses believes that the tech market in the future and proposed expansion in the tech market using their excess money. Do you agree with the genius? Explain your reason for agreement or disagreement. Can you come up with better use of the excess free cash flow?

Part 2) How would a fall in inflation affect the security market line? A fall in risk aversion?

Expert Solution

Ans 1) There is two way a firm can use the excess cash flow one is to invest in the new opportunity or the other way to distribute the cashflwo with the share holders keeping cash will lead to increase in reatianed earning which can hamper the the return on equity of the firm but it can be used for the future projects. But in this case company is trying its hand in technology sector which is a very risky expansion because company has no history of technology which will be dangerous in case company not turned up well in future, it required whole new steup and increase the intial cost as well as there will be new kind of resources will be required whether human or electricals. Thus this all things will increase the risk of the company and there is chance that all cost can become loss due to that I will be in disagreement of this proposal.

There are other better option like distributing the excess cash flow with the share holders or keeping it with the future projects. Company can also aquire the other firms in that case it will be having monopoly in the market but this can be risky due to complinace issue. Otherwise company can invest in any related business in respect to chocolate milk this will be very good for the firm.

Ans 2) Fall in inflation will give more money to the investor in that case risk free rate will increase due to more return on the risk free security which will eventually increase the level of security market line. At the same time investor will be having more money that will decrease the risk aversion of the investor and they will put more money into the market lead to increase in expectation of return on equity.

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