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    Cost of Capital for Risks

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    Chapter 13
    7. Each of the six firms in the table below is expected to pay the listed dividend payment every year in perpetuity.

    Firm Dividend ($million) Cost of capital (% /year)
    S1 10 8
    S2 10 12
    S3 10 14
    B1 100 8
    B2 100 12
    B3 100 14

    a. Using the cost of capital in the table, calculate the market value of each firm.
    b. Rank the three S firms by their market values and look at how their cost of capital is ordered. What would be the expected return for a self financing portfolio that went long on the firm with the largest market value and shorted the firm with the lowest market value? (the expected return of a self financing portfolio is the weighted average return of the consituent securities. Repeat using B firms.
    c. Rank all six firms by their market values. How does this ranking order the cost of capital? What would be the expected return for a self financing portfolio that went long on the firm with the largest market value and shorted the firm with the lowest market value?
    d. Repeat part ( c) but rank the firms by the dividend yield instead of the market value. What can you conclude about the dividend yield ranking compared to the market value ranking?

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    Chapter 13
    7. Each of the six firms in the table below is expected to pay the listed dividend payment every year in perpetuity.

    Firm Dividend ($million) Cost of capital (% /year)
    S1 10 8
    S2 10 12
    S3 10 14
    B1 100 8
    B2 100 12
    B3 100 14

    a. Using the cost of capital in the table, calculate the market value of each firm.
    Market value of firm with constant dividend = D1/r
    Firm Market Value
    S1 =10/8%=$125 million
    S2 =10/12%= $83.33 million
    S3 =10/14%=$71.43 million
    B1 =100/8%=$1250 million
    B2 =100/12%=$833.33 million
    B3 =100/14%=$714.3 ...

    Solution Summary

    The cost of capitals for risks are examined.

    $2.19

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