Chapter 13 Solutions

Chapter 13 Solutions - Chapter 13 Risk Return and Capital...

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Chapter 13: Risk, Return, and Capital Budgeting 13.2 Apply the CAPM to express the firm’s cost of equity capital, R S , in terms of the firm’s beta, β , the risk–free rate, R F , and the expected market return, R M . R S = R F + β × ( R M R F ) = 0.045 + 1.3 (0.12–0.045) = 0.1425 13.4 a. To compute the beta of Mercantile’s stock, divide the covariance of the stock’s return with the market’s return by the market variance. Since those two values are provided in the problem, the 13 quarterly returns of Mercantile’s stock and the market are not needed for the calculation. β D = Cov ( R D , R M ) / σ 2 M = (0.038711) / (0.038588) = 1.0032 The beta of Mercantile Banking Corporation is 1.0032. b. The beta of the average stock is one. Since Mercantile’s beta is close to one, its stock has approximately the same risk as the overall market. 13.6 a. Lang Cosmetics should use its stock beta in the evaluation of the project only if the risk of the perfume project is the same as the risk of Lang Cosmetics as a whole. b. If the risk of the project is the same as the risk of the firm, use the firm’s stock beta. Otherwise, Lang should use the beta of an all–equity firm that has similar risks as the perfume project. An effective way to estimate the beta of the perfume project is to average the betas of several all–equity, perfume–producing firms. 13.8 The pretax cost of debt is the YTM of the company’s bonds, so: P 0 = \$1,050 = \$40 + \$1,000 / (1+r) 24 24 r Α r = 3.683% YTM = 2 × 3.683% = 7.37% And the aftertax cost of debt is: r B = .0737(1 – .35) = .0479 or 4.79% 13.10 The book value of debt is the total par value of all outstanding debt, so: B = \$20M + 80M = \$100M To find the market value of debt, we find the price of the bonds and multiply by the number of bonds. Alternatively, we can multiply the price quote of the bond times the par value of the bonds. Doing so, we find: Answers to End–of–Chapter Problems B– 186

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B = 1.08(\$20M) + .58(\$80M) = \$68M The YTM of the zero coupon bonds is: P Z = \$580 = \$1,000
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This note was uploaded on 06/10/2010 for the course ACTSC 372 taught by Professor Maryhardy during the Winter '09 term at Waterloo.

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Chapter 13 Solutions - Chapter 13 Risk Return and Capital...

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