Problem Set 9 Checkpoints

Problem Set 9 Checkpoints - BusM 401 Problem Set#9 Cost of...

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BusM 401 Problem Set #9 Cost of Capital Solutions 1. Use the CAPM to find the expected rate of return (cost of equity) on the following stocks. (Assume a risk-free rate of 5% and a 9% risk premium on the market portfolio.) Briefly explain why these different stocks have different expected returns. COMPANY BETA EXPECTED RETURN General Mills 0.70 11.3% Bristol-Myers Squibb 1.13 Amazon.com 2.48 2. Find the appropriate cost of equity for DEF Corporation (using comparable firms’ betas) based on the following information: Comparable firm #1’s debt ratio = 50% DEF Corporation’s debt ratio = 20% Comparable firm #1’s equity (levered) beta = 1.2 Market risk premium = 8% Comparable firm #2’s debt ratio=35% Current long-term treasury rate = 6% Comparable firm #2’s equity beta = 0.8 K E =11.6% 3. Do Higgins, Chapter 8, #1. For part (c), you may want to read the box on p. 321 “The Fallacy of Marginal Cost of Capital”. Answers in back of book. 4. Do Higgins, Chapter 8, #4.
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