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171ahwk4_f11

# 171ahwk4_f11 - ARE 171a Fall 2011 Homework 4 Due Wednesday...

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ARE 171a Fall 2011 Homework 4 Due Wednesday, Nov. 30, in class 1. Consider 2 firms, which are identical except for their capital structure: Firm A sold 20 million shares of stock @ \$20/share (all-equity financed) Firm B sold 10 million shares of stock @ \$20/share, and \$200 million in long term bonds at coupon rate of 8% In the upcoming year, suppose there is a 1/3 chance of a strong economy, a 1/3 chance of an average economy, and a 1/3 chance of a weak economy. In an average year, sales are \$100 million, and cost of goods sold is 60% of sales. In a strong year, sales increase by 20% to \$120 m., with a proportional increase in cost of goods sold. In a weak year, sales decline by 20% to \$80 m., with a proportional decrease in cost of goods sold. In each case, depreciation is \$12 million, and taxes are 25% of EBT. Find EAT, EPS, ROA, and ROE for each firm, under strong, average and weak economic conditions. Now, find the mean, std. dev and coefficient of variation of EPS, for firm A and firm B. What type of risk effect does this illustrate? 2. a. Starwood Corp. recently paid a dividend of \$0.80/share. Its beta estimate is 1.2, and its expected dividend growth is 5%. Find investors’ required rate of return for this stock, and the stock’s current stock price,

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171ahwk4_f11 - ARE 171a Fall 2011 Homework 4 Due Wednesday...

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