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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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The JBH Corp expects to pay a dividend next year of $2.22. It expects its cash dividends to grow 5% per year forever. JBH has a debt ratio of L = 35%. Its borrowing rate is rd =9%. JBH pays corporate taxes at the rate of 30%, rf = 6%, rm = 12%, and JBH's common stock is currently selling for $20 per share. Answer the below quesitons.
1) what is the current (leveraged) required return, re, on JBH's common stock?
2) What is JBH's WACC?
3) What is JBH's unleveraged required return, r?
4) What unleveraged beta is implied by r?
5) What would you say about the estimates in parts (1) thru (4) if you learned that the market model estimated a (leveraged) beta of 2.2 for JBH's common stock?

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