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| 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?
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| 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?
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| c) What is the portfolio Beta of an asset with 30% of the funds invested in asset A and 70% invested in asset B?
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| 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?
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| 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?
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| 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?
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| b) What is the cost of debt?
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| c) What are the capital structure weights
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| d) What is this firm’s weighted average cost of capital?
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| e) When is it appropriate to use WACC?
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| f) Describe the Subjective approach to adjusting WACC
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| g) Describe the Pure Play approach to adjusting WACC | |
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| 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?
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| b) What is the cost of equity?
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| c) What is the cost of debt?
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| d) What is this firm’s WACC?
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| e) What is the weighted average flotation cost?
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| f) What is the initial costs including flotation costs?
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| g) What are the Cash Flows from Assets each year for this project?
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| h) Using NPV analysis how much value is created or destroyed by this project? Should your company accept or reject this project? |