Question: You have the following information for the company "Spear". The "beta" coefficient for "Sear" is 1.21 based on the past information. The 5-year average of 30-day T-bill rate is 2%, the average market return of (say, S&P 500 index) in the same period is 16%.
Answer the following questions:
a) What is the required rate of return for "Spear"? Why do we call it "required" rate of return?
1) 21.36%
2) 18.94%
3) 24%
4) 32.8%
5) 25.7%
b) Suppose the current dividend for "Spear" is $3.2 per share with possible expected growth rate as 7.5% per year from now on, what is the present value of Spear's stock?
1) $24.82
2) $32.16
) $19.31
4) $30.07
5) none of the above.
c) Suppose without using the information of "beta", the current market price for the "Spear's stock is $28.72 per share. Let the capital market be efficient as ideally assumed. That is, the current stock price is equal to the stock's present value. What is the required rate of return for this stock now if the information in (b) still applies?
1) 18.79%
2) 19.48%
3) 21.21%
4) 20.98%
5) none of the above
d) What is the "beta" of this stock now given the information in c)?
1) 1.248
2) 1.614
3) 2.053
4) 1.092
5) none of the above.
e) "Spear" has the following capital structure: the firm issued 7 million shares of common stock with the stock price given in (c) and dividend in (b), the firm also issued 2 million shares of preferred stock with $1.29 preferred dividend per share, and currently, "Spear" has $90 million in debts with interest rate as 6%. Suppose the current preferred stock price is $6.72 per share. The corporate tax rate is 30% and the common stock price is as given in c), what is the (after-tax) weighted average cost of capital (after tax) for "Spear"?
f) What is meaning of "Weighted Average Cost of Capital (after tax)"? Why do we usually apply it as the discount rate for expected future cash flows in capital budgeting decisions?