5) Equity of Freeway Inc. has a beta of 1.4 and beta of debt is 0.2. Freeway has a debt to equity ratio of 0.3. The equity beta of Sunshine Company is 2 while its debt has a beta of zero. Sunshine's debt to equity ratio is 0.5. Make following assumptions and answer these questions: Assumptions: (a) CAPM holds, (b) Expected return on market portfolio = 19%, (c) Risk-free rate = 8%, (d) There are no taxes or costs of financial distress a. What discount rate to use if Freeway Inc. wishes to invest in the business line of Sunshine. b. If Freeway goes ahead with investment, these projects constitute 10% of Freeway's overall value. If its debt beta and debt/equity ratio remain unchanged, post-investment, what will be the Freeway's new equity beta?

5) Equity of Freeway Inc. has a beta of 1.4 and beta of debt is 0.2. Freeway has a debt to equity ratio of 0.3. The equity beta of Sunshine Company is 2 while its debt has a beta of zero. Sunshine's debt to equity ratio is 0.5. Make following assumptions and answer these questions: Assumptions: (a) CAPM holds, (b) Expected return on market portfolio = 19%, (c) Risk-free rate = 8%, (d) There are no taxes or costs of financial distress a. What discount rate to use if Freeway Inc. wishes to invest in the business line of Sunshine. b. If Freeway goes ahead with investment, these projects constitute 10% of Freeway's overall value. If its debt beta and debt/equity ratio remain unchanged, post-investment, what will be the Freeway's new equity beta?

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter8: Analysis Of Risk And Return

Section: Chapter Questions

Problem 14P

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Similar questions

Market equity beta measures the covariability of a firms returns with all shares traded on the market (in excess of the risk-free interest rate). We refer to the degree of covariability as systematic risk. The market prices securities so that the expected returns should compensate the investor for the systematic risk of a particular stock. Stocks carrying a market equity beta of 1.20 should generate a higher return than stocks carrying a market equity beta of 0.90. Nonsystematic risk is any source of risk that does not affect the covariability of a firms returns with the market. Some writers refer to nonsystematic risk as firm-specific risk. Why is the characterization of nonsystematic risk as firm-specific risk a misnomer?
The LoLev Corporation's equity has a beta of 1.4. Its debt has a beta of 0.2. Its debt-to-value ratio is 30%. The HiLev Corporation's equity has a beta of 2. Its debt has a beta of zero. HiLev's debt-tovalue ratio is 40%. The riskfree rate is 8%, and the expected return on the market portfolio is 14%. Assuming the CAPM holds, and that there are no taxes or costs of financial distress, answer the following: a) LoLev is thinking of investing in the same line of business that HiLev is engaged in. What discount rate should it use? b) Now suppose the LoLev Corporation has decided to invest in HiLev's line of business. These projects now constitute 50% of the overall value of the LoLev's Corporation. Assuming that its debt-to-value ratio and the beta of its debt remain unchanged, calculate the new value of LoLev's equity beta.
Which statement is correct, all else held constant? A. If you have both the dividend growth and the security market line's costs of equity, you should use the higher of the two estimates when computing WACC. B. The aftertax cost of debt increases when the market price of a bond increases. C. A decrease in a firm's WACC will increase the attractiveness of the firm's investment options. D. Beta is used to compute the return on equity and the standard deviation is used to compute the return on preferred.
Wild Swings, Inc.'s stock has a beta of 2.1. If the risk-free rate is 5.9% and the market risk premium is 7.1%, what is an estimate of Wild Swings' cost of equity? Wild Swings, Inc.'s cost of equity capital is ______%
Suppose you estimate that stock A has a volatility of 32% and a beta of 1.42, whereasstock B has a volatility of 68% and a beta of 0.75.(a) Which stock has more total risk?(b) Which stock has more market risk?(c) Suppose the risk-free rate is 2% and you estimate the market’s expected return as10%. Which firm has a higher cost of equity capital
Steady Company's stock has a beta of 0.24. If the risk-free rate is 6.1% and the market risk premium is 6.9%, what is an estimate of Steady Company's cost of equity?
Steady Company's stock has a beta of 0.15. If the risk-free rate is 5.9% and the market risk premium is 6.8%, what is an estimate of Steady Company's cost of equity? Steady's cost of equity capital is _________%.
The Lenzie Corporation's common stock has a beta of 1.80. If the risk - free rate is 4.9% and the expected return on the market is 11%, what is the company's cost of equity capital? (Do not round intermediate calculations. Enter your answer as a percentage rounded to 2 decimal places.) Cost of equity capital %
Steady Company's stock has a beta of 0.21. If the risk-free rate is 5.9% and the market risk premium is 6.9%, what is an estimate of Steady Company's cost of equity?
Suppose the risk free rate is 2, 32%, the expected return of the market portfolio is 5, 64% and the beta of stock X-Bros S. A. is 1. 10. What is the expected cost of equity of X-Bros S. A. (in percent)?
(c) Explain why, in general, the portfolio risk is lower than the weighted average of individual stocks’ risk. (d) Suppose the risk-free rate is 4%, the market risk premium is 15% and the betas for stocks X and Y are 1.2 and 0.2 respectively. Using the CAPM model, estimate the required rates ofreturn of Stock X and Stock Y. (e) Given the results above, are Stocks X and Y overpriced or underpriced? Explain.
Suppose you estimate that stock A has a volatility of 32% and a beta of 1.42, whereas stock B has a volatility of 68% and a beta of 0.75. (a) Which stock has more total risk? (b) Which stock has more market risk? (c) Suppose the risk-free rate is 2% and you estimatethe market’s expected return as 10%. Which firm has a higher cost of equity capital?