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WACC, Beta

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Question 1: The AI corporation has a $150 M worth of common stock on which investors require a 17% rate of return. It also has $35 M in bonds that offer a 7% return.

a) Compute the WACC assuming that AI is subject to a 40% tax rate.

b) Re-compute the WACC assuming that the firm has $85 M in debt and $100 M in stock.

c) Explain why the WACC computed in b) may not be the correct answer if the capital structure changes.

Question 2 : Look at the Microsoft Excel file. In this file you will find the price of 2 stocks, ATR and FUL. In the same spreadsheet you will also find data for the S&P500 index - all the data are from the NYSE.

a) For each stock and for the market compute the daily rate of return {see attachment}, where {see attachment} is the price of stock i at time t. Then estimate the CAPM-beta for ATR and FUL.

b) Explain the "nature" of the beta you estimated.

c) Assume that the risk free rate is 5%. Further assume that the expected return for the market is 11%. What is cost of equity for ATR and FUL?

d) Assume that ATR and FUL have a capital structure composed only of equity. What is the WACC of ATR and FUL?

e) ATR is a well-diversified company and FUL is a specialized company - i.e. ATR invests and operates in several sectors while FUL invests and operates only in a sector. Assume you did not compute CAPM-betas and WACC, in your opinion, which company should be riskier? Does your estimate confirm your intuition?

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Solution Summary

WACC, Beta, cost of equity using CAPM have been calculated/estimated.

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