Sample Test 2(3) - Math 3650 Sample Test 2 Note The real...

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Math 3650 Sample Test 2 Note: The real test will contain short answer type questions in addition to these types of problems. 1. Given the following data for a company: Debt (D) = $400 million; Equity (E) = $600 Million; D r = 6%; E r = 15% and corporate tax rate = 35%. Calculate the weighted average cost of capital (WACC): Solution 1 400 600 0.06 1 0.35 0.15 400 600 400 600 10.56% WACC D E x D E r r t r D E D E 2. The expected return of the stock market is 9% The volatility of the stock market is 17.0% The expected return of your firm’s stock is 15% The volatility of your firm’s returns is 35% The covariance of your firm’s stock and the market is 3.468% Calculate your firm’s Beta Answer: Beta = Cov(firm,market)/Var(market) = .03468/(.17*.17) = 1.2 Or can do it this way: ( ) ( , ) ( ) xyz xyz mkt mkt Vol R Corr R R Vol R ( , ) ( , ) ( ) ( ) xyz mkt xyz mkt xyz KT Cov R R Corr R R Vol R Vol R Corr=.03468/(.35*.17)=.582857 .35 .582857 1.2 .17
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3. Use this information to answer the next three questions. The risk free rate is 4% and the expected return of the stock market is 9%. Based on a statistical analysis, you determined the volatility and beta for Exxon-Mobil and Merck to be: Stock Volatility Beta Exxon-Mobil 28% 0.9 Merck 24% 1.1 a. Which stock has the highest total risk? Answer: Exxon Mobil, since it has the highest volatility b. Which stock has the highest systematic risk? Answer: Merck, since it has the higher Beta c. If you were the Chief Financial Officer at Exxon Mobil, what is the cost-of-capital you would use to decide whether or not to pursue a project, using the principles of the Capital Asset pricing Model?
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