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Chapter 6 Page 172 Problem 4 Info: Corporation's Data Beta Debt Preferred Common 0.1 0.4 1.

5 Total 10% 5%

HW prob

Market Value $ % of total 100,000 25% 200,000 50% 100,000 25% 400,000 100%

Riskless interest rate Market Risk Premium

Calculate: a). Discount rates for each security

kd = rf + Bd(rm-rf)
Debt discount rate Preferred discount rate Common discount rate b). The asset beta for the corporation Ba = beta x the weight Debt 0.1 Preferred 0.4 10.50% 12.00% 17.50%

25% 50%

0.025 0.2

Common Ba =

1.5

25%

0.375 0.6

c). The weighted average cost of capital (WACC)

ko = weke + wdkd (1-t) + wpkp


Debt 0.1050 Debt discount rate 0.2500 % of total 0.0263 0.1200 0.5000 0.0600 0.1750 0.2500 0.0438 13.0%

Preferred

Common

WACC

d). The discount rate for the unlevered assets The business risk is the same for the unlevered assets as it is for the firm, so the discount rate for the unlevered assets is the same as the cost of capital for the company 13.0%

Chapter 6 Page 172 Problem 5 Shebert Theater wants to purchase a movie theater chain, Consolidated Info: Cinemas, which is owned by Tryon Info on movie house chains

HW prob similar to sample problem 2 in the text

Be

1). Equity portion of total 1 2.5 1 10 1 2 1 1.33 0.60 0.90 0.50 0.25 1.00 1.00 1.00 1.00

2).

Movie House NCO Theater, Inc. Worldwide/Global Screen Rocks Ultimate Theater Risk free rate Market risk premium

Equity debt to total Betas assets Beta D/TA 1.70 0.40 0.50 0.10 2.50 0.50 (0.10) 0.75 7.5% 8.5%

D/E

Asset Beta

0.67 0.11 1.00 3.00 total average asset beta

1.02 0.45 1.25 -0.025 2.695 0.67375

3).

a). What is the cost of equity capital for Consolidated? 1). transfer the debt to asset ratio to the debt to equity ratio

D/E = D/(TA - D)
Equ 6.3, page 149

2).

Ba =

Be
1 + D/E
Use equ 6.1, page 146 Beta x Project risk premium + Risk-free rate

3). Total asset betas & find average 4). average asset beta Market risk premium 0.67375 0.085

Risk free rate Cost of capital

0.05727 0.075 + 0.13227 13.23%

b). What qualifications would you include with your estimate? Can the companies chosen in this study serve as a good substituition or proxy?

Chapter 6 Estimating the Project Cost of Capital HW Problem Soda has 4 divisions: Be Contribution to Firm's Value 35% 10% 30% 25% 100% D/TA (debt to total assets 0.20 0.33 0.50 0.25
as a fraction

Company Coke Pepsi Gatorade Rootbeer

Equity Beta 2.00 1.50 1.25 0.50

1 1 1 1

5 3 2 4

Coke Pepsi Gatorade Rootbeer

D/E 0.25 0.50 1.00 0.33

Asset Cost of Beta Capital (%) 1.60 15.60% 1.00 12.00% 0.625 9.75% 0.38 8.25%

a).

Estimate the asset betas for Soda divisions, assume the debt betas are -0-, ignore taxes transfer the debt to asset ratio to the debt to equity ratio

D/E = D/(TA - D)
Coke Pepsi Gatorade Rootbeer Equ 6.3, page 149 0.25 0.50 1.00 0.33 D/E D/E D/E D/E

Ba =

Be
1 + D/E
Coke Pepsi Gatorade Rootbeer 1.60 1.00 0.63 0.38 Asset beta Asset beta Asset beta Asset beta

b).

Info given: Risk free rate avg market rate of return 6% 12%

rf rm

0.06 0.12

What is cost of capital for each of the divisions? using CAPM

kpp = rf + Ba(rm - rf)


0.1560 0.1200 0.0975 0.0825 0.5 With a D/TA of 0.50, what is Soda Company's equity beta? Coke Pepsi Gatorade Rootbeer with D/TA D/E = equity beta = equity beta = Coke Pepsi Gatorade Rootbeer

cost of capital 15.60% 12.00% 9.75% 8.25%

c).

cont 35% 10% 30% 25% 0.50 1.00 1.883

Asset Beta 1.600 1.000 0.625 0.375 weighted avg

cont x asset beta 0.5600 0.1000 0.1875 0.0938 0.9413

d).

If the debt of each division also had a beta = 0.50, what would be the cost of capital for each division? For Soda Company?

0.5

Ba = (D/TA)Bd + (E/TA)Be
D/TA (debt to total assets 0.20 0.33 0.50 0.25

Company Coke Pepsi Gatorade Rootbeer

Asset Beta Cost of Capital % 1.70 16.20% 1.17 13.02% 0.88 11.25% 0.50 9.00%

E/TA 0.80 0.67 0.50 0.75

D/TA Bd E/TA Be Risk free rate avg market rate of return What is cost of capital for each of the divisions? CAPM

Coke 0.20 0.5 0.80 2.00 6% 12%

Pepsi 0.33 0.5 0.67 1.5

Gatorade 0.50 0.5 0.50 1.25 0.060 0.120

Rootbeer 0.25 0.5 0.75 0.5 0.06 rm - rf

rf rm
Cost of Capital

kpp = rf + Ba(rm - rf)


Coke Pepsi Gatorade Rootbeer

0.162 0.1302 0.1125 0.09

Weights 35% 10% 30% 25%

Asset Beta 1.70 1.17 0.88 0.50 weighted avg. asset beta CAPM cost of capital for Soda Company = 12.60% Risk free rate 0.06 weighted avg. asset beta 1.10

Company Coke Pepsi Gatorade Rootbeer

0.595 0.117 0.263 0.125 1.100

Definition of 'Unlevered Beta' A type of metric that compares the risk of an unlevered company to the risk of the market. The unlevered beta is the beta of a company without any debt. Unlevering a beta removes the financial effects from leverage.