Reading 45: Cost of Capital-LOS i 习题精选 2011, interpret, structure, capital, whether

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Session 11: Corporate Finance
Reading 45: Cost of Capital

LOS i: Calculate and interpret the beta and cost of capital for a project.

 

 

Affluence Inc. is considering whether to expand its recreational sports division by embarking on a new project. Affluence’s capital structure consists of 75% debt and 25% equity and its marginal tax rate is 30%. Aspire Brands is a publicly traded firm that specializes in recreational sports products. Aspire has a debt-to-equity ratio of 1.7, a beta of 0.8, and a marginal tax rate of 35%. Using the pure-play method with Aspire as the comparable firm, the project beta Affluence should use to calculate the cost of equity capital for this project is closest to:

A) 1.18.

B) 0.38.

C) 0.58.

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The unlevered asset beta is:

Affluence’s debt-to-equity ratio = 0.75/0.25 = 3. To calculate the project beta, re-lever the asset beta using Affluence’s debt-to-equity ratio and marginal tax rate:

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A publicly traded company has a beta of 1.2, a debt/equity ratio of 1.5, ROE of 8.1%, and a marginal tax rate of 40%. The unlevered beta for this company is closest to:

A) 0.632.

B) 1.071.

C) 0.832.

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The unlevered beta for this company is calculated as:

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Utilitarian Co. is looking to expand its appliances division. It currently has a beta of 0.9, a D/E ratio of 2.5, a marginal tax rate of 30%, and its debt is currently yielding 7%. JF Black, Inc. is a publicly traded appliance firm with a beta of 0.7, a D/E ratio of 3, a marginal tax rate of 40%, and its debt is currently yielding 6.8%. The risk-free rate is currently 5% and the expected return on the market portfolio is 9%. Using this data, calculate Utilitarian’s weighted average cost of capital for this potential expansion.

A) 5.7%.

B) 4.2%.

C) 7.1%.

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Degen Company is considering a project in the commercial printing business. Its debt currently has a yield of 12%. Degen has a leverage ratio of 2.3 and a marginal tax rate of 30%. Hodgkins Inc., a publicly traded firm that operates only in the commercial printing business, has a marginal tax rate of 25%, a debt-to-equity ratio of 2.0, and an equity beta of 1.3. The risk-free rate is 3% and the expected return on the market portfolio is 9%. The appropriate WACC to use in evaluating Degen’s project is closest to:

A) 8.9%.

B) 9.2%.

C) 8.6%.

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Hodgkins’ asset beta:

We are given Degen’s leverage ratio (assets-to-equity) as equal to 2.3. If we assign the value of 1 to equity (A/E = 2.3/1), then debt (and the debt-to-equity ratio) must be 2.3 ? 1 = 1.3.

Equity beta for the project:

β_PROJECT = 0.52[1 + (1 ? 0.3)(1.3)] = 0.9932

Project cost of equity = 3% + 0.9932(9% ? 3%) = 8.96%

Degen’s capital structure weight for debt is 1.3/2.3 = 56.5%, and its weight for equity is 1/2.3 = 43.5%.

The appropriate WACC for the project is therefore:
0.565(12%)(1 ? 0.3) + 0.435(8.96%) = 8.64%.