Tutorial 8 CAPM and WACC PDF

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Week 8 Lecture material on CAPM and WACC for the tutorial in Week 9....

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Tut 8 – CAPM and WACC , chapters 12 and 13

Chapter 12 Q7 Suppose that the S&P 500, with a beta of 1.0, has an expected return of 10% and T-bills provide a riskfree return of 4%. a) How would you construct a portfolio from these two assets with an expected return of 8%? Specifically, what will be the weights in the S&P 500 versus T-bills? b) How would you construct a portfolio from these two assets with a beta of .4? c) Find the risk premiums of the portfolios in parts (a) and (b), and show that they are proportional to their betas.

Chapter 13 Q 7. Look at the following book-value balance sheet for University Products, Inc. The preferred stock currently sells for $15 per share and pays a dividend of $2 a share. The common stock sells for $20 per share and has a beta of .8. There are 1 million common shares outstanding. The market risk premium is 10%, the risk-free rate is 6%, and the firm’s tax rate is 40%.

a. What is the market debt-to-value ratio of the firm? b. What is University Product’s Weighted Average Cost of Capital?

Chapter 13. Q16 Here is a simplified balance sheet for Epicure Pizza (figures in $ millions): Assets

Liabilities and Shareholders’ Equity

Current assets

$ 80 Current liabilities

$ 60

Fixed assets

_125 Long-term debt

65

Equity Total

$205 Total

__80 $205

Note: There are 16 million shares outstanding. Epicure shares are currently priced at $12 each. (LO13-3) a) You wish to calculate Epicure’s WACC. What is the relevant figure for the company’s debt ratio? b) You now realize that since Epicure issued its debt, interest rates have fallen substantially. Do you need to revise your measure of the debt ratio upward or downward?

Chapter 13. Q19 Bunkhouse Electronics is a recently incorporated firm that makes electronic entertainment systems. Its earnings and dividends have been growing at a rate of 30%, and the current dividend yield is 2%. Its beta is 1.2, the market risk premium is 8%, and the risk-free rate is 4%. (LO13-4) a) Use the CAPM to estimate the firm’s cost of equity. b) Now use the constant growth model to estimate the cost of equity. c) Which of the two estimates is more reasonable?

Chapter 12 Q17 The following table shows betas for several companies. Calculate each stock’s expected rate of return using the CAPM. Assume the risk-free rate of interest is 4%. Use a 7% risk premium for the market portfolio. Company

Beta Expected return

Caterpillar

1.63

15.41%

Cisco

1.24

13%

Harley-Davidson

0.82

9.5%

Hershey

0.24

5.68%...