a. Estimate the beta of an unlevered firm in the commuter airline business based on Jaxair's market-determined beta. Do not round intermediate calculations. Round your answer to three decimal places. 1.36 b. Now assume that rd = TRF = 9% and that the market risk premium RPM = 4%. Find the required rate of return on equity for an unlevered. commuter airline. Do not round intermediate calculations. Round your answer to three decimal places. % c. Air Tampa is considering three capital structures: (1) $1 million debt, (2) $2 million debt, and (3) $3 million debt. Estimate Air Tampa's rs for these debt levels. Do not round intermediate calculations. Round your answers to two decimal places. 1. Air Tampa's rs for $1 million debt: 2. Air Tampa's rs for $2 million debt: 3. Air Tampa's rs for $3 million debt: % % %
a. Estimate the beta of an unlevered firm in the commuter airline business based on Jaxair's market-determined beta. Do not round intermediate calculations. Round your answer to three decimal places. 1.36 b. Now assume that rd = TRF = 9% and that the market risk premium RPM = 4%. Find the required rate of return on equity for an unlevered. commuter airline. Do not round intermediate calculations. Round your answer to three decimal places. % c. Air Tampa is considering three capital structures: (1) $1 million debt, (2) $2 million debt, and (3) $3 million debt. Estimate Air Tampa's rs for these debt levels. Do not round intermediate calculations. Round your answers to two decimal places. 1. Air Tampa's rs for $1 million debt: 2. Air Tampa's rs for $2 million debt: 3. Air Tampa's rs for $3 million debt: % % %
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Concept explainers
Risk and return
Before understanding the concept of Risk and Return in Financial Management, understanding the two-concept Risk and return individually is necessary.
Capital Asset Pricing Model
Capital asset pricing model, also known as CAPM, shows the relationship between the expected return of the investment and the market at risk. This concept is basically used particularly in the case of stocks or shares. It is also used across finance for pricing assets that have higher risk identity and for evaluating the expected returns for the assets given the risk of those assets and also the cost of capital.
Question
Transcribed Image Text:Air Tampa has just been incorporated, and its board of directors is grappling with the question of optimal capital structure. The company
plans to offer commuter air services between Tampa and smaller surrounding cities. Air Tampa believes it would have the same business
risk as Jaxair, which is an airline that has been around for a few years and that has had zero growth. Jaxair's market-determined beta is
1.8, and it has a current market value debt ratio (total debt to total assets) of 40% and a federal-plus-state tax rate of 25%. Air Tampa
expects to have investment tax credits when it begins business, which reduces its federal-plus-state tax rate to 20%. Air Tampa's owners
expect that the total book and market value of the firm's stock, if it uses zero debt, would be $16 million. Air Tampa's CFO believes that the
MM and Hamada formulas for the value of a levered firm and the levered firm's cost of capital should be used because zero growth is
expected.
a. Estimate the beta of an unlevered firm in the commuter airline business based on Jaxair's market-determined beta. Do not round.
intermediate calculations. Round your answer to three decimal places.
1.36
b. Now assume that rd = TRF = 9% and that the market risk premium RPM = 4%. Find the required rate of return on equity for an unlevered
commuter airline. Do not round intermediate calculations. Round your answer to three decimal places.
%
c. Air Tampa is considering three capital structures: (1) $1 million debt, (2) $2 million debt, and (3) $3 million debt. Estimate Air Tampa's rs
for these debt levels. Do not round intermediate calculations. Round your answers to two decimal places.
1. Air Tampa's rs for $1 million debt:
2. Air Tampa's rs for $2 million debt:
3. Air Tampa's rs for $3 million debt:
d. Suppose Air Tampa's investment tax credits expire, causing it to have a 25% federal-plus-state tax rate. Calculate Air Tampa's rs at $3
million debt using the new tax rate. (Hint: The increase in the tax rate causes Vu to drop to $15 million.) Do not round intermediate
calculations. Round your answer to two decimal places.
%
%
%
%
Compare this with your corresponding answer to Part c. (Assume that growth is zero and no personal taxes for the MM.)
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