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# Investment return (in percentage terms) for the year

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1) International investment returns Joe Martinez, a U.S. citizen living in Brownsville, Texas, invested in the common stock of Telmex, a Mexican corporation. He purchased 1,000 shares at 20.50 pesos per share. Twelve months later, he sold them at 24.75 pesos per share. He received no dividends during that time.

a. What was Joe's investment return (in percentage terms) for the year; on the basis of the peso value of the shares?

b. The exchange rate for pesos was 9.21 pesos per US\$1.00 at the time of the purchase. At the time of the sale, the exchange rate was 9.85 pesos per US\$1.00. Translate the purchase and sale prices into US\$.

c. Calculate Joe's investment return on the basis of the US\$ value of the shares.

d. Explain why the two returns are different. Which one is more important to Joe? Why?

2) A firm wishes to assess the impact of changes in the market return on an asset that has a beta of 1.20.
a. If the market return increased by 15%, what impact would this change be expected to have on the asset's return?
b. If the market return decreased by 8%, what impact would this change be expected to have on the assets return?
c. If the market return did not change, what impact, if any, would be expected to have on the assets return?
d. Would this asset be considered more of less risky than the market? Explain

3) Portfolio betas Rose Berry is attempting to evaluate two possible portfolios,
LG5
which consist of the same five assets held in different proportions. She is particu-
larly interested in using beta to compare the risks of the portfolios, so she has
gathered the data shown in the following table.

Portfolio weights
Asset Asset beta -Portfolio A -Portfolio B

1. 1.30 10% 30%
2. 70 30 10
3. 1.25 10 20
4. 1.10 10 20
5. 90 40 20
Totals 100% 100%

a. Calculate the betas for portfolios A and B.
b. Compare the risks of these portfolios to the market as well as to each other.
Which portfolio is more risky?

4) Use the basic equation for the capital asset pricing model (CAPM) to work each of the following problem.
a. Find the required return for an asset with a beta of 0.90 when the risk-free rate and market return are 8% and 12% respectively.
b. Find the risk-free rate for a firm with a required return of 15% and a beta of 1.25 when the market return is 14%.
c. Find the market return for an asset with a required return of 16% and a beta of 1.10 when the risk-free rate is 9%.
d. Find the beta for an asset with a required return of 15% when the risk-free rate and market return are 10% and 12.5% respectively.

5) Edna Recording Studios, Inc., reported earnings available to common stock of \$4,200,000 last year From those earnings, the company paid a dividend of \$1.26 on each of its 1,000,000 common shares outstanding. The capital structure of the company includes 40% debt, 10% preferred stock, and 50% common stock. It is taxed at a rate of 40%.
a. If the market price of the common stock is \$40 and dividends are expected to grow at a rate of 6% per year for the foreseeable future, what is the company's cost of retained earnings financing?
b. If underpricing and flotation costs on new shares of common stock amount to \$7.00 per share, what is the company's cost of new common stock financing?
c. The company can issue \$2.00 dividend preferred stock for a market price of \$25.00 per share. Flotation costs would amount to \$3.00 per share. What is the cost of preferred stock financing?
d. The company can issue \$l,000-par-value, 10% coupon, 5-year bonds that can be sold for \$1,200 each. Flotation costs would amount to \$25.00 per bond. Use the estimation formula to figure the approximate cost of debt financing.
e. What is the WACC?

6) Lang Enterprises is interested in measuring its overall cost of capital. Current investigation has gathered the following data. The firm is in the 40% tax bracket.

Debt The firm can raise an unlimited amount of debt by selling \$1,000-par-
value, 8% coupon interest rate, 20-year bonds on which annual interest
payments will be made. To sell the issue, an average discount of \$30 per bond
would have to be given. The firm also must pay flotation costs of \$30 per bond.

Preferred stock The firm can sell 8% preferred stock at its \$95-per-share
par value. The cost of issuing and selling the preferred stock is expected to be
\$5 per share. An unlimited amount of preferred stock can be sold under these
terms.

Common stock The firms common stock is currently selling for \$90 per share.
The firm expects to pay cash dividends of \$7 per share next year. The firms
dividends have been growing at an annual rate of 6%, and this is expected to
continue into the future. The stock must be underpriced by \$7 per share, and
flotation costs are expected to amount to \$5 per share. The firm can sell an
unlimited amount of new common stock under these terms.

Retained earnings. When measuring this cost, the firm does not concern itself
with the tax bracket or brokerage fees of owners. It expects to have available
\$100,000 of retained earnings in the coming year; once these retained earnings
are exhausted, the firm will use new common stock as the form of common
stock equity financing.
a. Calculate the after-tax cost of debt
b. Calculate the cost of preferred stock
c. Calculate the cost of common stock
d. Calculate the firms weighted average cost of capital using the capital structure weights shown in the following table. Round answers to the nearest .1%
Source of capital Weight

Long-term debt 30%
Preferred stock 20
Common stock equity 50
Total 100%

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#### Solution Preview

Corporate Finance
1) International investment returns Joe Martinez, a U.S. citizen living in Brownsville, Texas, invested in the common stock of Telmex, a Mexican corporation. He purchased 1,000 shares at 20.50 pesos per share. Twelve months later, he sold them at 24.75 pesos per share. He received no dividends during that time.

a. What was Joe's investment return (in percentage terms) for the year; on the basis of the peso value of the shares?

b. The exchange rate for pesos was 9.21 pesos per US\$1.00 at the time of the purchase. At the time of the sale, the exchange rate was 9.85 pesos per US\$1.00. Translate the purchase and sale prices into US\$.

c. Calculate Joe's investment return on the basis of the US\$ value of the shares.

d. Explain why the two returns are different. Which one is more important to Joe? Why?

2) A firm wishes to assess the impact of changes in the market return on an asset that has a beta of 1.20.
a. If the market return increased by 15%, what impact would this change be expected to have on the asset's return?
b. If the market return decreased by 8%, what impact would this change be expected to have on the assets return?
c. If the market return did not change, what impact, if any, would be expected to have on the assets return?
d. Would this asset be considered more of less risky than the market? Explain

3) Portfolio betas Rose Berry is attempting to evaluate two possible portfolios,
LG5
which consist of the same five assets ...

#### Solution Summary

Solution helps in calculating investment return (in percentage terms) for the year

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