Abc Acquitsion

Corpo poseValuation ProblemSet2 Dr. ZachariasSautner Ifnoinformationaboutthepremiumhasbeen grantedinthequestionsbelow,you canusethe informationformthefollowingtable Arithmeticaverage GeometricAverage Stocks? Stocks? Stocks? Stocks? HistoricalPeriod T. Bills T. Bonds T. Bills T. Bonds 1928? 2004 7. 92% 6. 53% 6. 02% 4. 84% 1964? 2004 5. 82% 4. 34% 4. 59% 3. 47% 1994? 2004 8. 60% 5. 82% 6. 85% 4. 51% Foralong? boundinvestorthe nonrepresentationalaveragewithtreasurybonds(4. 4%)isused. Forashort? margininvestorthe arithmeticaveragewithtreasurybills(7. 92%)isused. Inbothcasesthelongestpossibleperiodistaken. Solutions 1. InDecember1995,BoiseCascades linehadabetaof0. 95. Thetreasurybill rateatthetimewas5. 8%,andthetreasurybondratewas6. 4%. Thefirmhad debtoutstandingof$1. 7billionanda merchandisevalueof beauteousnessof$1. 5billion thecorporate borderlinetaxratewas36%. a. accounttheexpected checkonthestockforashortterminvestorin thecompany. b.Estimatetheexpectedreturnont hestockforalong? terminvestorin thecompany. c. Estimatethecostofequityforthecompany. a. WeusetheCAPM TheExpectedReturnonthestock=0. 058+0. 95(0. 0792)=0. 1332=13. 32% Sincetheinvestorisashort? terminvestor,weusetheT? billrate,andthearithmetic mean. Sincethefocusisshort? term,wedontneedtotakecompoundinginto account. 1 b. Foralong? terminvestor,wewouldusetheT? bondrate,andthegeometricmean Theexpectedreturn=0. 064+0. 95(0. 0484)=0. 1or11%,where4. 84%isusedas the guessofthemarket stakepremium,sincethatisthegeometricaverageofthe marketpremiumusingthelong? termT? bondrateastheriskfreerate. c. Thecostofequityforthecompanyismoreappropriatelythelong? termrequired rateofreturn,sincemostprojectsforthecompanywouldbelong? term. 2. BoiseCascadehaddebtoutstandingof$1. 7billionandhadamarketvalueof equityof$1. 5billionthecorporatemarginaltaxratewas36%. a. Assuming that the current beta of 0. 5 for the stock is a reasonable one,estimatetheunleveredbetaforthecompany. b. How much of the risk in the com pany can be attributed to business riskandmuchtofinancialleverage? c. a. Theleveredbetaofthecompanyisgivenbyformula ? (levered)= (unlevered)(1+(1-tax rate)(D/E)) Solving, we get ? unlevered = 0. 95/(1+(1-0. 36)(1. 7/1. 5)) = 0. 55 b. Theproportionoftheriskofthefirmsequitythatcanbeattributedtobusiness riskis0. 55/0. 95=58%,whiletheremainderisduetofinancialleveragerisk. 3.Genting Berhard is a Malayan conglomerate, with holdings in plantations andtouristresorts. Thebetaestimatedforthefirm,relativetotheMalaysian stock exchange, is 1. 15, and the long? term government borrowing rate in Malaysiais11. 5%. (Malaysianriskpremiumis12%). a. Estimatetheexpectedreturnonthestock. b. If you were an external investor, what concerns, if any, would you have about using the beta estimated relative to the Malaysian index? Ifyoudo,howwouldyoumodifythebeta? . Theexpectedreturnonthestock,assumingthatthemarginalinvestorisa Malaysianwithprimarilydomesticholdingsis0. 115+1. 15(0. 12)=25. 30%,using theriskpr emiumbasedoncountryriskprovidedbyratingsagencies. b. Foraninternationalinvestor,whohastheabilitytodiversifyglobally,someof theriskmightbediversifiable,andhencethetruebetamightbelower. Totake careofthispossibleoverstatement,itwouldbeappropriatetocomputeabeta relativetoamoreglobalindex,suchastheMorganStanleyCapitalIndex. . YouhavejustdonearegressionofmonthlystockreturnsofHeavyTechInc. , amanufacturerofheavymachinery,onmonthlymarketreturnsoverthe hold out five daysandcomeupwiththefollowingregression RHeavyTech=0. 5%+1. 2RM 2 Thevarianceofthestockis50%,andthevarianceofthemarketis20%. The currentT. billrateis3%. (Itwas5%oneyearago). Thestockiscurrentlyselling for$50,down$4overthe stretch outyear,andhaspaidadividendof$2duringthe lastyearandexpectstopayadividendof$2. 50overthenextyear.TheNew YorkStockExchange(NYSE)compositehasgonedown8%overthelastyear, withadividendyieldof3%. HeavyTechInc. hasataxrateof40%. a. WhatistheexpectedreturnonHeavyTechoverthenextyear? b. WhatwouldyouexpectHeavyTec hspricetobeoneyearfromtoday? c. WhatwouldyouhaveexpectedHeavyTechsstockreturnstobeover thelastyear? d. WhatweretheactualreturnsonHeavyTechoverthelastyear? e. HeavyTechhas$100millioninequityand$50millionindebt. Itplans to issue $50 million in young equity and retire $50 million in debt. Estimatethenewbeta.