Question

Project ABC has an expected return on total capital that is above required return of the outside investor, and where the investor and the entrepreneum plan to had identical ownership claim. Also consider the market is competitive.

Provide an example to determine the amount the investor should contribute in order to acquire a fixed percentage of the equity. (consider to return>require)

Answer 1

Answer:

For project ABC , the expected return on capital invested by the shareholder is greater than the required return by the investor.

entrepreneur ownership claim=investor ownership claim.

the investor wants a fixed percentage of equity. the shareholder's expected return is more than investors required rate of return.

So the shareholder would like to hold more percentage of equity. As both plan to have equal ownership claims. The investor can demand that percentage where he can expect a required return on the equity he is holding and even get right to exercise his claim of ownership.

Explanation:

We can understand the process of determining the amount at which the investor can buy the same is is explained through CAPM Model.

The Capital Asset Pricing Model (CAPM) describes the relationship between systematic risk and expected return for assets, particularly stocks. CAPM is widely used throughout finance for pricing risky securities and generating expected returns for assets given the risk of those assets and cost of capital.

Example:

imagine an investor is contemplating a stock worth $100 per share today that pays a 3% annual dividend. The stock has a beta compared to the market of 1.3, which means it is riskier than a market portfolio. Also, assume that the risk-free rate is 3% and this investor expects the market to rise in value by 8% per year.

The expected return of the stock based on the CAPM formula is 9.5%.