Report on Financial Analysis on Wonderland Confectionaries

4) Using the stock price and return data in Exhibits 5 and 6, estimate the CAPM beta

At the new WACC of 19%, the home appliance and agricultural machinery projects are valued based on their inherent levels of risk. The beta of the industry average home appliance project is 0.95, whereas the beta for the industry average agricultural machine project is calculated as 0.88. CAPM was then employed to find the cost of capital of each project. The cost of capital for the home appliance and agricultural machinery projects were found to be 10.4% and 9.92%, respectively (Appendix B). This analysis allows Star Company to allocate funds to projects that create returns greater than the industry cost of capital for each specific project.

12. Using the data from the previous question, what trade is necessary to increase the beta of the portfolio to 1.8 from the original beta of 1.5

Star Appliance is looking to expand their product line and is considering three different projects: dishwashers, garbage disposals, and trash compactors. We want to determine which project would be worth doing by determining if they will add value to Star. Thus, the project(s) that will add the most value to Star Appliance will be worth pursuing. The current hurdle rate of 10% should be re-evaluated by finding the weighted average cost of capital (WACC). Then by forecasting the cash flows of each project and discounting them by the WACC to find the net present value, or by solving for the internal rate of return, we should be able to see which projects Star should undertake.

Cost of Equity = Risk Free Rate + Beta Equity*(Average Market Return – Risk Free Rate)

The three parks looking at being invested in are Six Flags, Sea World and Cedar Fair. Six Flags has the highest net income (see chart) with Cedar fair with the second highest and sea world in last. This isn’t bad for any of the companies, but when looking at the return on sales, again Six Flags is first, with Cedar Fair in second and Sea world with half of what the other two have. The story is the same for current ratio and stockholder’s equity. However, return on equity the number one and two spot switches with Cedar Fair in first, Six Flags in second and Sea World in last, again. Return on equity followed this new trend with a 7% difference between the number one and two spot. Debt-to-equity ratio showed Cedar fair with the highest, Sea World coming in with the second highest and Six Flags coming in with the lowest. Until I looked at earnings per share, my mind was made up; I was going with Six Flags for its excellent return on sales, current ratio and comparatively better

1-a How can the CAPM be used to estimate the cost of capital for a real business investment decision?

Please refer to Appendix 2 for other considerations for cost of equity calculations. Most firms use the Capital Asset Pricing Model (CAPM) to determine the cost of equity. The components that make up the CAPM include: the risk free rate, the beta of the security, and the expected market return of the stock. These values are all based on forward-looking data. The model dictates that shareholders require a return equal to the return from a risk-free investment plus an equity risk premium for bearing extra risk. Refer to Appendix 1 for a full breakdown of the CAPM formula.

This essay will highlight the use of Capital asset pricing model ( CAPM ) to be considered as a pricing theory model for assets . CAPM model helps investors to analyse the risk and what expectation to keep from an investment (Banz , 1981) . There are two types of risk

Of these 6 comparable companies, 3 of them are kitchen and bath companies and the rest 3 deals with engines and generators. Hence an average of the asset beta has been taken for these two sub groups which represent different business segments. Finally to arrive at the asset beta which would reflect the riskiness/volatility of Kohler, weighted average of these two betas has been taken as provided in the calculations below:

For this variable we take again the same risk free rate (4.66%) plus the equity market risk premium (5%) multiplied by the equity Beta of the E & P division (1.40). The beta we calculate with the comparables. The average equity beta in this industry is 1.15 and the average D/E ratio is 39.8%. With these information and the same formula as in question 3 we compute the asset beta

Using the stock price and returns data in Exhibits 4 and 5 (or, if you wish, other equivalent data sources), and the capital structure information in Exhibit 3, calculate the asset betas for the comparable firms. What is the appropriate estimation period to compile the data?

We added the market risk premium of 6% to the 4.60% because 6% is the rate that investors want above the risk free rate due to the risk of the investment. This equals 10.6% which is then multiplied by the beta of the company of 1.1. Beta is a measure of the stock’s volatility in relation to the market. A beta of 1.1 means that Worldwide Paper Company has slightly higher volatility than the market does. The total cost of equity then calculates to equal 11.2%. This tells us that given the risk taken in investing in the company, a shareholder should expect an 11.2% return.

ANS: Different projects should be set according to their risks and expected returns, even though they are in a given division. The various situation and market fluctuation for each project might lead to different returns. So Pioneer should set the cost of capital and weights distinctly among those projects. Because Beta represents the risk of a project and different projects show different risks, Beta used to calculate the CAPM should be determined depending on the risks. In addition, in determination of weights of debt and equity, they should also consider differently because initially Pioneer set half and half. But we believe in the future capital budgets, being more specific when setting the weight instead of just evenly distributed would be more reasonable.

Instead, we can compute the βu[C] with the relationship of each division and the corporation.