You have just done a regression of monthly stock returns of HeavyTech, a manufacturer of heavy machinery, on monthly market returns over the past five years and come up with the following regression:

The variance of the stock is 50 percent, and the variance of the market is 20 percent. The current Treasure bill rate is 3 percent (it was 5 percent one year ago). The stock is currently selling for $50, down $4 over the past year, and has paid a dividend of $2 during the past year and expects to pay a dividend of $2.50 over the next year. The NYSE composite has gone down 8 percent over the past year, with a dividend yield of 3 percent. HeavyTech has a tax rate of 40 percent.

a. What is the expected return on HeavyTech over the next year?

b. What would you expect HeavyTech’s price to be one year from today?

c. What would you have expected HeavyTech’s stock returns to be over the past year?

d. What were the actual returns on HeavyTech over the past year?

e. HeavyTech has $100 million in equity and $50 million in debt. It plans to issue $50 million in new equity and retire $50 million in debt. Estimate the new beta.


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