| 3) | (10
points) You are an investment fund manager who can allocate funds
between two stocks or form a portfolio of these two stocks. Stock A has a
Beta of 1.65 and Stock B has a Beta of 0.55. The market portfolio is
expected to return 11.8% and the T-bill rate is 3.2%. |
| | |
| | a) What is the expected return on each stock?
|
| | b) What is the expected return on a portfolio that consists of $37,500 invested in asset A and $62,500 invested in asset B?
|
| | c) What is the portfolio Beta of an asset with 30% of the funds invested in asset A and 70% invested in asset B?
|
| | d) A
client of yours wants a portfolio that has an expected return of 9.5%.
How much must be invested in asset A and how much in asset B to
accomplish this?
|
| | e) Suppose
that Stock A actually returns 15% and Stock B returns 9% what should be
expect to happen to the prices and returns of Stock A and B? Which is
underpriced and which one is overpriced?
|
| 4) | (10
points) Your firm is considering a project that is considered average
risk by your firm. Overall your firm’s Beta is 0.77, the expected market
risk premium is 9.8%, and the risk free rate of return is 3.1%. Your
firm also has 7.4% semi-annual coupon bonds with 9 years until maturity
currently selling for 108.50% of par value. The corporate tax rate is
35% and your firm has a D/E ratio of 1.25. |
| | |
| | a) What is the cost of equity?
|
| | b) What is the cost of debt?
|
| | c) What are the capital structure weights
|
| | d) What is this firm’s weighted average cost of capital?
|
| | e) When is it appropriate to use WACC?
|
| | f) Describe the Subjective approach to adjusting WACC
|
| | g) Describe the Pure Play approach to adjusting WACC |
| |
|
| 5) | (20
Points) Your firm has 1 million shares of common stock each selling for
$68.50 and the par value of bonds issued is $50 million but the bonds
are currently priced at 98.25% of par. The bonds are 14 year semi-annual
6.2% coupon bonds. Your firm just paid a dividend of $2.12 per share
and this is expected to increase by 8% each year. The tax rate is
currently 30%. A project under consideration is expected to generate
revenues of $1,000,000 per year over the next four years but requires an
initial investment in fixed assets of $1.2 million and $150,000
invested in net working capital (which will be recovered). Revenues are
expected to remain steady over the next four years and variable costs
account for 54% of revenues. Fixed costs are anticipated to be $120,000
per year. The fixed asset has a useful life of four years and a salvage
value of $200,000. Your firm will depreciate this asset using the
straight-line method. To finance this project’s initial costs your firm
will need to issue new stocks and bonds. The flotation cost of equity is
8.4% and the flotation cost of debt is 6.1% |
| | |
| | a) What are the capital structure weights for this firm?
|
| | b) What is the cost of equity?
|
| | c) What is the cost of debt?
|
| | d) What is this firm’s WACC?
|
| | e) What is the weighted average flotation cost?
|
| | f) What is the initial costs including flotation costs?
|
| | g) What are the Cash Flows from Assets each year for this project?
|
| | h) Using
NPV analysis how much value is created or destroyed by this project?
Should your company accept or reject this project?
|
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