Please read all questions and instructions carefully. Note that you only need to enter answers in terms of numbers and without any symbols (including $, %, commas, etc.). Enter all dollars without decimals and all interest rates in percentage with up to two decimals. Read the syllabus for examples.The points for each question are listed in parentheses at the start of the question, and the total points for the entire assignment adds up to 100. In accordance with the Coursera Honor Code, I (Shravan Vepa) certify that the answers here are my own work. Thank you! Question 1
(5 points) In a world with no frictions (i.e., taxes, etc.), having debt is always better because it increases the value of the firm/project. False.
(5 points) The return on equity is equal to the return on assets of a project/firm. Always true.
(10 points) Moogle, Inc. is in the same business as Google, Inc., but has recently retired all its debt to become an all-equity firm. Its return on equity has dropped from 12.25% to 10.60% as a result of this. Google, Inc. continues to have debt in its capital structure, and its debt-to-equity ratio is 30%. What is the return on assets of Google, Inc.(No more than two decimals in the percentage interest rate, but do not enter the % sign.) Answer for Question 3
(10 points) Suppose CAPM holds, and the beta of the equity of your company is 2.00. The expected market risk premium (the difference between the expected market return and the risk-free rate) is 4.5% and the risk-free rate is 3.00%. Suppose the debt-to-equity ratio of your company is 20% and the market believes that the beta of your debt is 0.20. What is return on assets of your business? (No more than two decimals in the percentage interest rate, but do not enter the % sign.) Answer for Question 4
(10 points) You are planning on opening a consulting firm. You have projected yearly cash flows of $2 million starting next year (t = 1) with a growth rate of 3% over the foreseeable future thereafter. This endeavor will require a substantial investment and you will have to convince investors to provide you the capital to do so. You will invest some of your own money, convincing other investors will of course be useful for your valuing your own investment decision. A critical piece of your analysis is figuring out the present value of the cash flows of the business. Your research has
revealed the following information: similar consulting businesses equity has an average beta of 2.40 and the average debt-to-equity ratio in this industry is 10%. The risk-free rate is 3.25% and the expected market risk premium (the average difference between between the market return and the risk-free rate) is 4.50%. What is the value of the cash flows of your business? 20060181.
Do not have enough information to value.
(10 points) Your firm has been plodding along without much attention from the stock market; both analysts and investors are not showing much interest in your company. Your boss insists that (a) he can increase the return on equity of the company by simply taking on more debt and (b) that will attract new investors to the firm because of the higher returns. False.
Partly true; partly false.
(10 points) Two firms, Alpha, Inc., and Beta, Inc., are in the same business. Alpha, Inc., has debt that is viewed by the market as risk-less with a market value of $500 million. Beta, Inc., has no debt. Both firms are expected to generate cash flows of $100 million per year for the foreseeable future and the market value of the equity of Beta, Inc is $1 billion. Estimate the return on equity of Alpha, Inc. Assume there are no taxes, and the risk-free rate is 5%. (No more than two decimals in the percentage interest rate, but do not enter the % sign.) Answer for Question 7
(10 points) Mango, Inc. has had debt with market value of $1 million that has paid a 6% coupon and has had an expiration date that is far, far away. The expected annual earnings before interest and taxes for the firm are $2 million and the firm has not grown, nor does it have plans for any growth. The firm however has just raised more equity to retire all its debt. If the required rate of return to equity-holders (after the capital structure
change) is now 20%, what is the market value of the firm? Assume there are no taxes. (Enter just the number without the $ sign or a comma; round to the nearest whole dollar.) Answer for Question 8
(15 points) Suppose all investors are risk-averse and hold diversified portfolios. You are evaluating a new drug company that is going to have two divisions: an R&D unit and a Sales unit. Your CEO and you are arguing about whether the two units should have the same cost of capital (WACC), or whether the discount rates should be different. If different, what should be the relative magnitudes of the discount rates, that is, which unit R&D or Sales should have the higher discount rate. Assume the discount rates of the two units are labeled as R (for R&D) and S (for Sales), respectively. What do you think? S>R.
The same discount rates for both divisions/units (R=S).
(15 points) NorthSouth Airlines has been granted permission to fly passengers between major U.S. cities. The new company faces competition from four airlines that operate between the major cities. The betas of the equity of the four major competitors (A, B, C, D) are 2.25, 2.50, 2.75, and 3.00; and the debt-to-equity ratios of these four companies (in the same order: A, B, C, D) are 0.21, 0.42, 0.63, 0.83. Although these D/E ratios vary, all airline debt is rated the same. Suppose the yield on airline debt is 7%, the risk-free rate is 3% and the expected market risk premium (the average difference between the market return and the risk-free rate) is 5%. What is the cost of capital (or discount rate) that you should use in valuing NorthSouth Airlines? (No more than two decimals in the percentage interest rate, but do not enter the % sign.) Answer for Question 10
In accordance with the Coursera Honor Code, I (Shravan Vepa) certify that the answers here are my own work. Thank you!