HW4_2023

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Stevens Institute Of Technology *

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Finance

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Feb 20, 2024

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Please ensure you write down detailed steps for all calculations to be eligible for full marks. Use the information for the question(s) below. Suppose you invest $20,000 by purchasing 200 shares of Abbott Labs (ABT) at $50 per share, 200 shares of Lowes Companies, Inc. (LOW) at $30 per share, and 100 shares of Ball Corporation (BLL) at $40 per share. 1) The weight on Lowes in your portfolio is: 2) Suppose over the next year Ball Corporation has a return of 12.5%, Lowes Companies has a return of 20%, and Abbott Labs has a return of -10%. The return on your portfolio over the year is: 3) Suppose you invest $15,000 in Merck stock and $25,000 in Home Depot stock. You expect a return of 16% for Merck and 12% for Home Depot. What is the expected return on your portfolio?

4) Suppose you have $10,000 in cash and you decide to borrow another $10,000 at a 6% interest rate to invest in the stock market. You invest the entire $20,000 in a stock ABC Inc with a 12% expected return and a 20% volatility. The expected return on your investment is: Use the information for the question(s) below. Suppose that you currently have $250,000 invested in a portfolio with an expected return of 12% and a volatility of 10%. The efficient (tangent) portfolio has an expected return of 17% and a volatility of 12%. The risk-free rate of interest is 5%. 5) The Sharpe ratio for your portfolio is: 6) The Sharpe ratio for the efficient portfolio is:

Use the following information to answer the question(s) below. The following information is for the equity of the firms: Beta Volatility "Eenie" 0.45 20% "Meenie" 0.75 18% "Miney" 1.05 35% "Moe" 1.20 25% Assume that the risk-free rate of interest is 3% and you estimate the market's expected return to be 9%. 7) The equity cost of capital for "Miney" is: 8) The risk premium for "Meenie" is:

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Use the following information to answer the question(s) below. Suppose all possible investment opportunities in the world are limited to the four stocks listed in the table below: Stock Price per Share Number of Shares Outstanding (Millions) Taggart Transcontinental $15.60 25 Rearden Metal $13.00 45 Wyatt Oil $29.25 10 Nielson Motors $26.25 26 9) The weight on Taggart Transcontinental stock in the market portfolio is:

Use the following information to answer the question(s) below. Beta Volatility "Eenie" 0.45 20% "Meenie" 0.75 18% "Miney" 1.05 35% "Moe" 1.20 25% Assume that the risk-free rate of interest is 3% and you estimate the market's expected return to be 9%. 7) The equity cost of capital for "Miney" is: 8) The equity cost of capital for "Meenie" is: Use the following information to answer the question(s) below. Year Risk-free Return Market Return Wyatt Oil Return Market Excess Return Wyatt Oil Excess Return 2007 3.0% 6.0% 5.5% 3.0% 2.5% 2008 1.5% -38.5% -32.6% -40.0% -34.1% 2009 1.0% 22.5% 19.6% 21.5% 18.6% 9) Using just the return data for 2009, your estimate of Wyatt Oil's beta is:

Use the following information to answer the question(s) below. Consider the following information regarding corporate bonds: Rating AAA AA A BBB BB B CCC Average Default Rate 0.0% 0.1% 0.2% 0.5% 2.2% 5.5% 12.2% Recession Default Rate 0.0% 1.0% 3.0% 3.0% 8.0% 16.0% 48.0% 10) Wyatt Oil has a bond issue outstanding with seven years to maturity, a yield to maturity of 7.0%, and a BBB rating. The bondholders' expected loss rate in the event of default is 70%. Assuming a normal economy, the expected return on Wyatt Oil's debt is: 11) Wyatt Oil has a bond issue outstanding with seven years to maturity, a yield to maturity of 7.0%, and a BBB rating. The bondholders' expected loss rate in the event of default is 70%. Assuming the economy is in recession, then the expected return on Wyatt Oil's debt is: 12) Rearden Metal has a bond issue outstanding with ten years to maturity, a yield to maturity of 8.6%, and a B rating. The bondholders' expected loss rate in the event of default is 50%. Assuming a normal economy, the expected return on Rearden Metal's debt is: Use the following information to answer the question(s) below. Luther Industries has 25 million shares outstanding trading at $18 per share. In addition, Luther has $150 million in outstanding debt. Suppose Luther's equity cost of capital is 13%, its debt cost of capital is 7%, and the corporate tax rate is 21%. 13) Luther's unlevered cost of capital is : 14) Luther's weighted average cost of capital is:

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Use the following information to answer the question(s) below. Nielson Motors (NM) has no debt. Its assets will be worth $600 million in one year if the economy is strong, but only $300 million if the economy is weak. Both events are equally likely. The market value today of Nielson's assets is $400 million. 15) The expected return for Nielson Motors stock without leverage is: Use the information for the question(s) below. Consider a project with free cash flows in one year of $90,000 in a weak economy or $117,000 in a strong economy, with each outcome being equally likely. The initial investment required for the project is $80,000, and the project's cost of capital is 15%. The risk-free interest rate is 5%. 16) Suppose that to raise the funds for the initial investment, the project is sold to investors as an all- equity firm. The equity holders will receive the cash flows of the project in one year. The market value of the unlevered equity for this project is: 17) Suppose that to raise the funds for the initial investment the firm borrows $80,000 at the risk-free rate, then the cash flow that equity holders will receive in one year in a weak economy is: 18) Suppose that to raise the funds for the initial investment the firm borrows $80,000 at the risk-free rate, then the cash flow that equity holders will receive in one year in a strong economy is:

19) Suppose that to raise the funds for the initial investment the firm borrows $80,000 at the risk-free rate, then the value of the firm's levered equity from the project is: 20) Suppose that to raise the funds for the initial investment the firm borrows $80,000 at the risk-free rate, then the cost of capital for the firm's levered equity is: 21) NRG Energy, Inc. (NRG) is an energy company with a market debt-equity ratio of 1.5. Suppose its current debt cost of capital is 3%, and its equity cost of capital is 16%. Suppose also that if NRG issues equity and uses the proceeds to repay its junior debt and reduce its debt-equity ratio to 1, it will lower its debt cost of capital to 1%. With perfect capital markets, what effect will this transaction have on NRG’s equity cost of capital and WACC? 22) NRG Energy, Inc. (NRG) is an energy company with a market debt-equity ratio of 1.5. Suppose its current debt cost of capital is 3%, and its equity cost of capital is 16%. Suppose also that if NRG issues equity and uses the proceeds to repay its junior debt and reduce its debt-equity ratio to 0. With perfect capital markets, what effect will this transaction have on NRG’s equity cost of capital and WACC?

Use the table for the question(s) below. Consider the following income statement for Kroger Inc. (all figures in $ Millions): Year 2006 2005 2004 Total sales 60,553 56,434 53,791 Cost of goods sold 45,565 42,140 39,637 Selling, general & admin expenses 11,688 12,191 11,575 Depreciation 1265 1256 1209 Operating income 2035 847 1370 Other income 0 0 0 EBIT 2035 847 1370 Interest expense 510 557 604 Earnings before tax 1525 290 766 Taxes (35%) 534 102 268 Net income 991 189 498 23) The interest rate tax shield for Kroger in 2006 is: 24) The interest rate tax shield for Kroger in 2005 is: 25) The income that would be available to equity holders in 2006 if Kroger was not levered is: 26) Assume that investors hold Google stock in retirement accounts that are free from personal taxes. Also assume that Google's current pre-tax WACC is 14% and the corporate tax rate is 21%. If Google’s debt cost of capital is 7 and debt-to-equity ratio is 1, then the Google's after-tax WACC is:

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27) Suppose DFB does not have any debt now. DFB start to restructure its existing debt, and will instead pay $30 million in interest each year for the next 10 years. These payments are risk free, and DFB ‘s marginal tax rate will remain 25% throughout this period. If the risk-free interest rate is 6%, by how much does the interest tax shield increase the value of DFB? 28) Taggart Transcontinental currently has no debt and an equity cost of capital of 16%. Suppose that Taggart decides to increase its leverage and maintain a market debt-to-value ratio of 1/3. Suppose Taggart's debt cost of capital is 9% and its corporate tax rate is 21%. Assuming that Taggart's pre-tax WACC remains constant, then with the addition of leverage its effective after-tax WACC will be: Use the information for the question(s) below. Flagstaff Enterprises expected to have free cash flow in the coming year of $8 million, and this free cash flow is expected to grow at a rate of 3% per year thereafter. Flagstaff has an equity cost of capital of 13%, a debt cost of capital of 7%, and it has a 35% corporate tax rate. 29) If Flagstaff currently maintains a .5 debt to equity ratio, then the present value of Flagstaff's total interest tax shield is: 30) Taggart Transcontinental has announced a $2 dividend. If Taggart's last price cum-dividend is $45, then, assuming perfect capital markets, what should its first ex-dividend price be?

Use the following information to answer the question(s) below. Wyatt Oil has assets with a market value of $600 million, $70 million of which are cash. It has debt of $250 million, and 20 million shares outstanding. Assume perfect capital markets. 31) Wyatt Oil's current stock price is : 32) If Wyatt Oil distributes the $70 million as a dividend, then its stock price after the dividend will be: