Question

Elbur Co. pays 40% in corporate taxes and is nanced entirely by common
stock with a 1,000 shares outstanding trading at $100 per share. Elbur's return on assets is equal
to 20%. Elbur has only assets-in-place and, thus, does not grow. The risk-free debt yields 5% and
the market return is equal to 12.5%. Let EPS stand for earnings per share, E for equity, and D for
debt.
(1) Calculate:
(i) (2 points) In this environment, what ecient portfolio (describe the porfolio's weights)
returns 8%?
(ii) (3 points) If the volatility of such ecient portfolio is equal to 10%, what is Elbur's market
risk?
(iii) (1 point) Elbur's (P/EPS) ratio;
(iv) (1 point) Elbur's EPS:

Answer 1

Calculation:
(i) In this environment, what ecient portfolio (describe the porfolio's weights)
returns 8%?

Portfolio

EQUITY- 12.5 (Return)

DEBT - 5% (Return)

Considering 50-50% Weight of equity and debt

Total Return= 12.5+5/2

=8.75%

(ii) If the volatility of such ecient portfolio is equal to 10%, what is Elbur's market
risk?

To measure market risk, investors and analysts use the value-at-risk (VaR) method. VaR modeling is a statistical risk management method that quantifies a stock or portfolio's potential loss as well as the probability of that potential loss occurring. While well-known and widely utilized, the VaR method requires certain assumptions that limit its precision. For example, it assumes that the makeup and content of the portfolio being measured is unchanged over a specified period. Though this may be acceptable for short-term horizons, it may provide less accurate measurements for long-term investments.

Considering Debt as Risk Free Instrument

Equity consist of Volatility Risk

Market Risk = 10% * 50%(Equity Portfolio) = 5% Market Risk

(iii) Elbur's (P/EPS) ratio;

Price/ Eps = 100/12.5

=8
(iv) ) Elbur's EPS: Income /Share

= (1000*100*0.125)/1000

=12.5