Q1) Omega Industries has 30mm shares outstanding trading for $15 per share and $90mm in outstanding debt. Omega's equity beta is 0.7. Its debt has a BBB rating and a beta of 0.1. Its corporate tax rate is 30%. The expected market return is 15%. The risk free rate is 5%.
a. What is Omega's unlevered cost of capital?
b. What is Omega's after-tax debt cost of capital?
c. What is Omega's weighted average cost of capital?
Q2) Consider two bonds A and B with the following characteristics that have the same price.
Annual Annual
Bond Coupon Rate Yield Maturity
A Zero 5% 4yrs
B ? 6% 5yrs
a. Calculate the price of Bond A as a percentage of its notional amount to two decimal places.
b. If you spent $10mm to purchase bond A, how much principal (in mm$ with two decimal places) would you receive on its maturity date?
c. Using the fact that bonds A and B have the same price, what is the coupon rate of bond B (as a percentage with two decimal places)?
d. If you spent $10mm to purchase bond B, what coupon payment (in $) will you receive each year?
Q3) The following data is an annual price history (ignores dividends) for GE, Amazon and the S&P500 index. Note: this data table can be highlighted (using shift-key) and pasted into Excel. Assume the risk free rate was zero.
|
GE
|
AMZN
|
S&P
|
|
1/4/2016
|
30.50
|
587.00
|
1940.24
|
|
1/2/2015
|
22.91
|
354.53
|
1994.99
|
|
1/2/2014
|
23.28
|
358.69
|
1782.59
|
|
1/2/2013
|
19.99
|
265.50
|
1498.11
|
|
1/3/2012
|
16.18
|
194.44
|
1312.41
|
|
1/3/2011
|
16.83
|
169.64
|
1286.12
|
|
1/4/2010
|
13.07
|
125.41
|
1073.87
|
|
1/2/2009
|
9.38
|
58.82
|
825.88
|
|
1/2/2008
|
25.95
|
77.70
|
1378.55
|
|
1/3/2007
|
25.67
|
37.67
|
1438.24
|
|
1/3/2006
|
22.64
|
44.82
|
1280.08
|
a. Using this data, calculate the average return of the AMZN and GE over this ten year time period.
b. Use the data to estimate the annual volatility of the AMZN and GE.
c. Estimate beta for GE and AMZN during this time period.
d. Consider a portfolio invested 25% in AMZN and 75% in GE. Calculate the volatility and beta of this portfolio.
Q4) Acme Co. is assessing it current capital structure. Acme is currently financed entirely with common stock with 1,000,000 shares outstanding. Investors currently expect a 12.5% market return and the risk free rate is 5%. The beta on Acme stock is 2. Acme pays out all earnings as dividends to common shareholders. Expected earnings (EBIT) generated by the firm's assets are $3,000,000 per year and expected to continue into perpetuity. Assume agency and bankruptcy costs are zero.
a. Assuming perfect capital markets and a corporate tax rate of zero, calculate:
i. The required rate of return on equity
ii. The value of the firm
iii. The share price
b. Acme's CEO has decided to issue debt so that the firms balance sheet will be split evenly between debt and equity. He plans to issue $7,500,000 of perpetual debt with a 10% annual rate and use the proceeds to repurchase equity. Again assuming perfect capital markets and a corporate tax rate of zero, calculate
i. The value of the firm
ii. The share price
iii. The required rate of return on equity
iv. The firm's weighted average cost of capital
c. Now assume the corporate tax rate is 40%. Calculate
i. The value of the firm
ii. The share price
iii. The required rate of return on equity
iv. The firm's weighted average cost of capital
Q5) Castle Rock Inc. will have one of three values at the end of next year: $200mm with 30% probability, $130mm with 50% probability or $70mm with 20% probability. The risk free rate is 5%. In the event of default, the 30% of Castle rock's assets will be lost to bankruptcy costs. Castle Rock has 2,500,000 shares outstanding. [Assume the risk of these outcomes is diversifiable, i.e. the outcomes are unrelated to the state of the economy and Castle Rock's beta is zero. Ignore taxes.]
a. What is the initial value of Castle Rock's equity without leverage?
b. What is the price per share of Castle Rock's equity without leverage?
Assume that Castle Rock issues $90mm face value of zero coupon debt due in one year.
c. What is the initial value of Castle Rock's debt?
d. What is the yield of Castle Rock's debt?
e. What is the value of Castle Rock's equity and it price per share with leverage?
f. What is Castle Rock's total firm value with leverage?