Corporate Finance
1. A portfolio manager has a $10 million portfolio, which consists of $1 million invested in 10 separate stocks. The portfolio beta is 1.2. The risk-free rate is 5% and the market risk premium (rM-rRF) is 6%.
a. What is the portfolio's required return?
b. The manager sells one of the stocks in her portfolio for $1 million. The stock she sold has a beta of 0.9. She takes the $1 million and uses the money to purchase a new stock that has a beta of 1.6. What is the required return of her portfolio after purchasing this new stock?
2. Central Development Company just paid a dividend of $3.00 per share. The company just entered a very profitable growth mode and expects that its dividend will grow 15% annually over the next three years. In the spirit of under promising and over delivering, Central Development has told investors that after the third year it expects the annual dividend to grow at a more reasonable rate of 2% per year. Currently, the risk free rate (RRF) is 2.5%, the market risk premium (RPM) is 6.5%, and Central's beta is 1.5.
a. If you want to buy Central's stock today, how much are you willing to pay?
b. If you buy Central's stock today, how much will you be able to sell it for at the end of year 4? (i.e., what is the stock's price at the end of year 4?)
3. Angell Inc. hired you as a consultant to help them estimate their cost of capital. You have been provided with the following data:
• Target capital structure is 40% debt, 15% preferred, and 45% common
• Tax rate is 25%.
• The before-tax cost of debt is 00%,
• The cost of preferred stock is 7.5%
• The cost of retained earnings is 74%
• It expects to pay $3.40 dividend at the end of this year and its expected constant dividend growth rate is 4.0%, and its common stock currently sells for $35.00 per share. Flotation cost can be ignored.
a. If the firm uses retained earnings and does not issue any new What is its WACC?
b. If the firm raise new common equity, how much higher will Angell Inc.'s WACC be?