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Finance Class Ver 6 Week 9 Problems




Question;1) In a world with no frictions (taxes, etc.), value is;created by how you finance a2) The return on equity is equal to the return on assets of;a project/firm.3) Suppose the expected returns on equity of two firms;Macrosoft and Microsoft, that operate in;the same industry are 10.50% and 12.60%, respectively. What is the return on;assets in this business if Macrosoft has no debt? (Enter the answer with no;more nor less than two decimal places, and leave off the % sign. For example;if your answer is 13.97% you should enter it as 13.97 NOT 0.14 nor 14).4) Suppose CAPM holds, and the beta of the equity of your;company is 2.00. The expected MARKET risk premium (the difference between the;expected MARKET return and the risk-free rate) is 4.5% and the risk-free rate;is 3.00%. Suppose the debt-to-equity ratio of your company is 20% and the;market believes that the beta of your debt is 0.20. What is return on assets of;your business? (Enter the answer with no more nor less than two decimal places;and leave off the % sign. For example, if your answer is 13.97% you should;enter it as 13.97 NOT 0.14 nor 14).5) You are planning on opening a consulting firm. You have;projected yearly cash flows of $2 million starting next year (t = 1) with a;growth rate of 3% over the foreseeable future thereafter. This endeavor will;require a substantial investment and you will have to convince investors to;provide you the capital to do so. You will INVEST some of your own money;convincing other investors will of course be useful for your valuing your own;investment decision. A critical piece of your analysis is figuring out the;present value of the cash flows of the business. Your research has revealed the;following information: similar consulting businesses equity has an average beta;of 2.40 and the average debt-to-equity ratio in this industry is 10%. The;risk-free rate is 3.25% and the expected market risk premium (the average;difference between the market return and the risk-free rate) is 4.50%. What is;the value of the cash flows of your business?18099548.20060181.6) Your firm has been plodding along without much attention;from the STOCK MARKET, both analysts and investors are not showing much;interest in your company. Your boss insists that (a) he can increase the return;on equity of the company by simply taking on more debt and (b) that will;attract new investors to the firm because of the higher returns.7) Two firms, ABC, Inc., and XYZ, Inc., are in the same;business. XYZ, Inc., has debt that is viewed by the market as risk-less with a;market value of $250 million. ABC, Inc., has no debt. Both firms are expected;to generate cash flows of $50 million per year for the foreseeable future and;the market value of the equity of ABC, Inc is $500 million. Estimate the return;on equity of XYZ, Inc. Assume there are no taxes, and the risk-free rate is 4%.;(Enter the answer with no more nor less than two decimal places, and leave off;the % sign. For example, if your answer is 13.97% you should enter it as 13.97;NOT 0.14 nor 14)8) Banana, Inc. has had debt with MARKET value of $0.5;million that has paid a 5% and has had an expiration date that is far;far away. The expected annual earnings before interest and taxes for the firm;are $1 million and the firm has not grown, nor does it have plans for any;growth. The firm however has just raised more equity to retire all its debt. If;the required rate of return to equity-holders (after the capital structure;change) is now 10%, what is the market value of the firm? Assume there are no;taxes. (Enter just the number without the $ sign or a comma, round to the;nearest whole dollar.)9) Suppose all investors are risk-averse and hold;diversified portfolios. You are evaluating a new drug company that is going to;have two divisions: an R&D unit and a Sales unit. Your CEO and you are;arguing about whether the two units should have the same cost of capital;(WACC), or whether the discount rates should be different. If different, what;should be the relative magnitudes of the discount rates, that is, which unit;R&D or Sales should have the higher discount rate. Assume the discount;rates of the two units are labeled as R (for R&D) and S (for Sales);respectively. What do you think?S>R.The same discount rates for both divisions/units (R=S).R>S.;10) AmRail has been granted permission to transport;passengers between major U.S. cities. The new company faces competition from;regional railway companies that operate between major cities in their regions.;The betas of the equity of the four major competitors (A, B, C, D) are 1.10;1.20, 1.30, and 1.40, and the debt-to-equity ratios of these four companies (in;the same order: A, B, C, D) are 0.10, 0.20, 0.30, 0.40. Although these D/E;ratios vary, all debt is considered risk-free in the market place because;railways are expected to dominate all long-distance public transportation.;Suppose the expected market risk premium (the average difference between the;market return and the risk-free rate) is 5% and the risk free rate is 4%. What;is the cost of capital (or discount rate) that you should use in valuing;AmRail? Assume there are no taxes. (Enter the answer with no more nor less than;two decimal places, and leave off the % sign. For example, if your answer is;13.97% you should enter it as 13.97 NOT 0.14 nor 14);="msonormal">


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