1. Suppose CAPM works, and you know that the expected returns on Google and IBM are estimated to be 11.75% and 9.00%, respectively. You have just calculated extremely reliable estimates of the betas of Google and IBM to be 1.45 and 0.91, respectively. Given this data, what is a reasonable estimate of the market risk-premium in percentage (the average/expected difference between the market return and the risk-free rate)?
2. Two firms, Alpha, Inc., and Beta, Inc., are in the same business. Alpha, Inc., has debt that is viewed by the market as risk-less with a market value of $550 million. Beta, Inc., has no debt. Both firms are expected to generate cash flows of $100 million per year for the foreseeable future and the market value of the equity of Beta, Inc is $1100 million. Estimate the percentage return on equity of Alpha, Inc. Assume there are no taxes, and the risk-free rate is 4.00%.
3. Mango, Inc. has had debt with market value of $4 million that has paid a 6.0% annual coupon and has had an expiration date that is far, far away. The expected annual earnings before interest and taxes for the firm are $8 million and the firm has not grown, nor does it have plans for any growth. The firm however has just raised more equity to retire all its debt. If the required rate of return to equity-holders (after the capital structure change) is now 23.0%, what is the market value of the firm? Assume there are no taxes.