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2 Assignment Solution 1. Suppose a stock had an initial price of $91 per share, paid a dividend of $2.40 per share during the year, and had an ending share price of $102. Compute the percentage total return. (b)what was the dividend yield? The capital gains yield? (c)Rework (a) and (b) assuming the ending share price is $83. 2. Using the following returns, calculate the arithmetic average returns, the variances, and the standard deviations for X and Y. Returns Year X Y 1 8% 16% 2 21 38 3 17 14 4 -16 -21 5 9 26 3. You find a certain stock that had returns of 7 percent, -12 percent, 18 percent, and 19 percent for four of the last five years. If the average return of the stock over this period was 10.5 percent, what was the stock’s return for the missing year? What is the standard deviation of the stock’s return? 4. You have $10,000 to invest in a stock portfolio. Your choices are Stock X with an expected return of 14 percent and Stock Y with an expected return of 10.5 percent. If your goal is to create a portfolio with an expected return of 12.4 percent, how much money will you invest in Stock X? In Stock Y? 5. A stock has a beta of 1.35 and an expected return of 16 percent. A risk -free asset currently earns 4.8 percent. (a) What is the expected return on a portfolio that is equally invested in the two assets? (b) If a portfolio of the two assets has a beta of 0.95, what are the portfolio weights? 6. Consider the following information about Stocks I and II: Rate of return if state occurs State of economy Probability of State of economy Stock I Stock II Recession 0.25 0.11 -0.40 Normal 0.50 0.29 0.10 Irrational exuberance 0.25 0.13 0.56 The market risk premium is 8 percent, and the risk-free rate is 4 percent. Which stock has the most systematic risk? Which one has the most unsystematic risk? Which stock is “riskier”? Explain. 7. Suppose you observe the following situation: Security Beta Expected return Pete Corp. 1.35 0.132 Repete Co. 0.80 0.101 Assume these securities are correctly priced. Based on the CAPM, what is the expected return on the market? What is the risk-free rate? 8. Stock Y has a beta of 1.3 and an expected return of 18.5 percent. Stock Z has a b eta of 0.70 and an expected return of 12.1 percent. If the risk-free rate is 8 percent and the market risk premium is 7.5 percent, are these stocks correctly priced? Assignment 3 Solution 1. Stock in Country Road Industries has a beta of 0.85. The market risk premium is 8 percent, and T-bills are currently yielding 5 percent. The company’s most recent dividend was $1.60 per share, and dividends are expected to grow at a 6 percent annual rate indefinitely. If the stock sells for $37 per share, what is your best estimate of the company’s cost of equity? 2. Titan Mining Corporation has 9 million shares of common stock outstanding, 250,000 shares of 6 percent preferred stock outstanding, and 105,000 7.5 percent semiannual bonds outstanding, par value of $1,000 each. The common stock currently sells for $34 per share and has a of beta 1.25, the preferred stock currently sells for $91 per share, and the bonds have 15 years to maturity and sell for 93 percent of par. The market risk premium is 8.5 percent, T-bills are yielding 5 percent, and Titan Mining’s tax rate is 35 percent. (a) What is the firm’s market value capital structure? (b) If Titan Mining is evaluating a new investment project that has the same risk as the firm’s typical project, what rate should the firm use to discount the project’s cash flows? 3. Big Time, Inc., is proposing a rights offering. Presently there are 500,000 shares outstanding at $81 each. There will be 60,000 new shares offered at $70 each. (a) What is the new market value of the company? (b) How many rights are associated with one of the new shares? (c) What is the ex-rights price? (d) What is the value of a right? (e) Why might a company have a rights offering rather than a general cash offer? 4. The Clifford Corporation has announced a rights offering to raise $40 million for a new journal, the Journal of Financial Excess. This journal will review potential articles after the author pays a nonrefundable reviewing fee of $5,000 per page. The stock currently sells for $53 per share, and there are 4.1 million shares outstanding. (a) What is the maximum possible subscription price? What is the minimum? (b) If the subscription price is set at $48 per share, how many shares must be sold? How many rights will it take to buy one share? (c) What is the ex-rights price? What is the value of a right? (d) Show how a shareholder with 1,000 shares before the offering and no desire (or money) to buy additional shares is not harmed by the rights offering. 5. Until It Sleeps Corporation expects an EBIT of $14,000 every year forever. Until It Sleeps currently has no debt, and its cost of equity is 16 percent. The firm can borrow at 9 percent. If the corporate tax rate is 35 percent, what is the value of the firm? What will the value be if the company converts to 50 percent debt? To 100 percent debt? 6. Empress Corp. has no debt but can borrow at 8.2 percent. The firm’s WACC is currently 11 percent, and the tax rate is 35 percent. (a) What is the company’s cost of equity? (b) If the firm converts to 25 percent debt, what will its cost of equity be? (c) If the firm converts to 50 percent debt, what will its cost of equity be? (d) What is the company’s WACC in part (b)? In part (c)? 7. (a) Wood Corp. uses no debt. The weighted average cost of capital is 9 percent. If the current market value of the equity is $23 million and there are no taxes, what is EBIT? (b) Suppose the corporate tax rate is 35 percent. What is EBIT in this case? What is the WACC? Explain. 8. Maxwell Industries has a debt-equity ratio of 1.5. Its WACC is 10 percent, and its cost of debt is 7 percent. The corporate tax rate is 35 percent. (a) What is the company’s cost of equity capital? (b) What is the company’s unlevered cost of equity capital? (c) What would the cost of equity be if the debt-equity ratio were 2? What if it were 1.0? What if it were zero? ... View Full Document