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will you hold more or fewer shares of Unilever relative that you would hold under the assumption that the CAPM is valid? Answers: Question 1 d) You should overweight Unilever in your portfolio relative to its weight in the index. lOMoARcPSD
Question 2 (Capital Structure; 15 points; 4,4,3,4) In October 2012, Obuma Entertainment had total equity market capitalization of $150 billion, and debt with a market value of $50 billion. Its equity beta is 2.0, while its debt is risk-free. The risk-free interest rate is 5% and the market risk premium is 4%. Assume perfect capital markets (where the Modigliani and Miller propositions hold). a)What is Obuma Entertainment’s Weighted Average Cost of Capital? b)Now suppose that Obuma Entertainment is considering to issue new debt to buy back some shares of its shareholders. More specifically it considers to buy back equity with new debt such that its debt will increase to $100 billion, and its equity will be reduced to $100 billion. Assume that debt will remain riskless what will be the equity beta, the cost of equity and the Weighted Average Cost of Capital after this transaction? c)If as a result of this transaction the beta of equity will not be as in b. but instead the beta of equity will increase to 3.5. How high must the beta of debt and the cost of debt be in that case? d)Explain how an increase in leverage could impact the value of Obuma Entertainment in a world without perfect capital markets. Two reasons must be based on the Trade-off theory and two from the Agency theory of leverage. Answers