Exam 11: Risk-Adjusted Expected Rates of Return and the Dividends Valuation Approach

Because the market equity beta reflects the level of operating leverage,financial leverage,variability of sales,and other characteristics of a firm,there are situations where an analyst might have to adjust the beta because of changes in the capital structure.A situation that might require an analyst to estimate a new levered beta is a ___________________________________.

The CAPM computes expected rates of return on common equity capital using the following model: E[REⱼ] = E[RF] + ⱼ x {E[RM] - E[RF]} What are the roles of each of the three components of this model?

Carr Industries must raise $100 million on January 1,2012 to finance its expansion into a new market.The company will use the money to finance construction of four retail outlets and a distribution center.The stores are expected to open later this year.The CFO has come up with three alternatives for raising the money: 1)Issue $100 million of 8% nonconvertible debt due in 20 years. 2)Issue $100 million of 6% nonconvertible preferred stock (100,00 shares). 3)Issue $100 million of common stock (1 million shares). The company's internal forecasts indicate the following 2012 year-end amounts before any option is chosen: Carr has no preferred stock outstanding but currently has 10 million shares of common stock outstanding.EPS has been declining for the past several years.Earnings in 2011 were $1 per share,which was down from $1.10 during 2010,and management wants to avoid another decline during 2012.One of the company's existing loan agreements requires a debt-to-equity ratio to be less than2.Carr pays taxes at a 40% rate. Required:1.Assess the impact of each financing alternative on 2012 EPS and the year-end debt to equity ratio. 2.Which financing alternative would you recommend and why?

Zonk Corp. The following data pertains to Zonk Corp., a manufacturer of ball bearings (dollar amounts in millions): Tetal a55ets \ 7460 Interest-bearing debt \ 3652 Average pre-tax borrowing cost 10.5\% Common equity: Boak value \ 2950 Market value \ 13685 Incame tax rate 35\% Market equity beta 1.13 -Assume that Zonk is a potential leveraged buyout candidate.Assume that the buyer intends to put in place a capital structure that has 70 percent debt with a pretax borrowing cost of 14 percent and 30 percent common equity.Compute the revised equity beta for Zonk based on the new capital structure.

Watson manufactures and sells appliances.Intro develops and manufactures computer technology.Trenton operates general merchandise retail stores.Selected data for these companies appear in the following table (dollar amounts in millions).For each firm,assume that the market value of the debt equals its book value. Required: a.Assume that the intermediate-term yields on U.S.Treasury securities are roughly 3.5 percent.Assume that the market risk premium is 5.0 percent. Compute the cost of equity capital for each of the three companies. b.Compute the weighted average cost of capital for each of the three companies. c.Compute the unlevered market (asset)beta for each of the three companies.

Bridgetron An analyst wants to value the sum of the debt and equity capital of the firm and is provided with the following information: -An analyst wants to value the common shareholders' equity of Bridgetron,compute the relevant cost of capital that should be used.

A company with a new Capital structure will increase the __________ and at the same time the __________ risk.

A company with a market beta of 1 has systemic risk ____________________ to the average amount of systemic risk of all equity securities in the market.

The following financial statement data pertains to Outside,Inc.,a manufacturer of men's outerware (dollar amounts in millions): Required:a.Calculate the company's cost of equity capital. b.Calculate the weight on debt capital that should be used to determine Outside's weighted-average cost of capital. c.Calculate the weight on equity capital that should be used to determine Outside's weighted-average cost of capital. d.Calculate Outside's weighted-average cost of capital.

One rationale for using expected dividends in valuation is

With respect to dividends and priority in liquidation,what has priority over common stock?

In theory,the value of a share of common equity is the present value of ____________________________________________________________.