Cases Questions

For the purpose of calculating the net present value of the project, an appropriate cost of capital has to be calculated at which free cash flows of the project should be discounted. Since the project will be solely financed by selling new shares, cost of equity will be used as the discount rate. Beta for the company can be assumed to be equal to average of the betas of the competitors of the company. This average beta value comes out to be 1.2. Risk free rate is 0.17% while risk premium has been estimated to be 6%. Thus by putting these values in CAPM formula, we can find the cost of equity for the company which is 7.39%.

3. Was the firm able to generate enough cash from operations to pay for all of its capital expenditures?

4. Based on your analysis in (1) – (3) above, what is your overall conclusion regarding the

15. How has the company’s stock been performing in the last 5 years? Steadily rising since 1/2009. Declining from 2007 – 2009 as expected due to the recession and the change in demand for construction.

a) In the first set of calculations, the staff used a discount rate of 20%, a five-year time horizon, and ignored taxes and terminal value. What is the relative attractiveness of these three alternatives?

What are some alternative ways to obtain a market risk premium for use in a CAPM cost-of-equity calculation? Discuss both the possibility of obtaining estimates from outside organizations and also ways which Ace could calculate a market risk premium itself.

Given these approximations, the CAPM model would total the risk-free rate and the market risk premium times beta to arrive at a cost of equity of 9.68%, which reflects the investors’ expected return from investing in shares of the company.

2. What do the results say about how firms in this industry can deliver strong financial returns in different ways?

5. Should the company seriously consider any other options besides doing a spin-off or issuing targeted stock?

7. What is the cost of capital for Marriott’s contract services division? How can you estimate its equity costs without

What is an appropriate required rate of return against which to evaluate the prospective IRRs from the Boeing

B) How well has Berkshire Hathaway performed? In the aggregate? In its investment in Scott & Fetzer? In its investments in earlier purchases of GEICO stock? In its investments in convertible preferred securities?

Solutions to Valuation Questions 1. Assume you expect a company’s net income to remain stable at $1,100 for all future years, and you expect all earnings to be distributed to stockholders at the end of each year, so that common equity also remains stable for all future years (assumes clean surplus). Also, assume the company’s β = 1.5, the market risk premium is 4% and the 20-30 year yield on risk free treasury bonds is 5%. Finally, assume the company has 1,000 shares of common stock outstanding. a. Use the CAPM to estimate the company’s equity cost of capital. • re = RF + β * (RM – RF) = 0.05 + 1.5 * 0.04 = 11% b. Compute the expected net distributions to stockholders for each future year. • D = NI – ΔCE = $1,100 – 0 = $1,100 c. Use the

c. Is your estimate of Lex’s cost of equity appropriate as a discount rate for Lex’s total operating cash flows? Why or why not?

1. What is the appropriate required rate of return against which to evaluate the prospective IRR 's from the B ANSWER:The appropriate rate of return against which to evaluate the IRR is the risk-free rate, plus the market risk