1. You have run a regression ofmonthlyreturns on a stock againstmonthlyreturns on the S&P 500 index, and come up with the following output:
Rstock= 0.25% + 1.25 RMarket R2
= 0.60
The current one-year treasury bill rate is 4.8%, the current ten-year bond rate is 7.25% and the current thirty-year bond rate is 8%. The firm has 10 million shares outstanding, selling for $10 per share.
Homework DUE DATE: 2/4/2020 1. You have run a regression of monthly returns on a stock against monthly returns on the S&P 500 index, and come up with the following output: Rstock = 0.25% + 1.25 RMarket R2 = 0.60 The current one-year treasury bill rate is 4.8%, the current ten-year bond rate is 7.25% and the current thirty-year bond rate is 8%. The firm has 10 million shares outstanding, selling for $10 per share. i. What is the expected return on this stock over the next year? ii. Would your expected return estimate change if the purpose was to get a discount rate to analyze a thirty-year capital budgeting project? iii. An analyst has estimated, correctly, that the stock did 4.2% better than expected, annually, during the period of the regression. Can you estimate the annualized riskfree rate that he used for his estimate? iv. The firm has a debt/equity ratio of 50% and faces a tax rate of 40%. It is planning to issue $50 million in new debt and acquire a new business for that amount, with the same risk level as the firm's existing business. What will the beta be after the acquisition? 2. Lister Inc. is a small, publicly traded data processing company that has $200 million in debt outstanding, in both book value and market value terms. The book value of equity in the company is $400 million and there are 40 million shares outstanding, trading at $20/share. The current levered beta for the company is 1.15 and the company’s pre-tax cost of borrowing is 5%. The current risk-free rate in US $ is 3%, the equity risk premium is 5% and the marginal tax rate is 40%. a. Estimate the current cost of capital for the company. b. Now assume that the company plans to triple its debt to capital ratio (through a recapitalization), which will raise the pre-tax cost of debt to 8%. If the expected pre-tax operating income of the firm is $36 million, estimate the new cost of capital. 3. Movie Inc., an entertainment conglomerate, has a beta of 1.60. Part of the reason for the high beta is the debt left over from the leveraged buyout of Pic Inc. in 2009, which amounted to $10 billion in 2014. The market value of equity at Movie Inc in 2014 was also $ 10 billion (and the book value of equity was also $10 billion). The marginal tax rate was 40%. a. Estimate the unlevered beta for Movie Inc. b. Estimate the effect of reducing the debt ratio (Total Debt/Total Assets) by 10% each year for the year (for example if the debt ratio was 40% it will be reduced to 30%) on the beta of the stock. Assume that Movie Inc has no short-term debt (i.e. TD=TL). 4. Ridley Inc. is a small, publicly traded construction company with 50 million shares outstanding trading at $10 a share. Ridley has: · Unlevered beta of 1.1 · One bank loan with interest payments of $5 million a year for 5 years and a principal payment (FV) of $250 million · Rating of Baa, for which the default spread is 2% · Marginal tax rate of 40% The risk-free rate is 2.5%, and the equity risk premium is 5.5%. What is the current cost of capital for Ridley? (hint: find the MV of debt using the data provided … in order words find the PV of the debt) 5. You are trying to estimate the cost of capital to use in assessing a new investment venture in the entertainment business, for TechSmith Inc, a publicly traded electronics company. You have been provided the following information: · The beta for TechSmith, based upon stock prices for the last 5 years, is 1.80 but the unlevered beta for entertainment companies is 1.20. · At the moment, TechSmith has one bank loan outstanding, with a principal payment due of $250 million at the end of 10 years and interest payments of $ 10 million every year for the next 10 years. TechSmith also has lease commitments of $20 million a year, due at the end of each year for the next 8 years. · TechSmith has 60 million shares outstanding, with a stock price of $20/share. · TechSmith has a bond rating of BB, with a default spread of 4.5% over the risk-free rate. The marginal tax rate if 40% but TechSmith’s effective tax rate is25%. · The risk-free rate is 3% and the equity risk premium is 6%. a. Estimate the market value of the interest-bearing debt. b. Estimate the debt value of lease commitments. c. Estimate the cost of capital for this project, assuming that it will be funded using the same debt ratio that TechSmith uses to fund itself today.