Question

1. Company A has a beta of 0.75, while Company B's beta is 1.20. The required return on the stock market is 11.00%, and the risk-free rate is 4.25%. What is the difference between A's and B's required rates of return? (Hint: First find the market risk premium, then find the required returns on the stocks.)

2. Emc corporation has never paid a dividend. its current free cash flow of 400000 is expected to grow at a constant rate of 5 percent. the weighted average cost of capital is wacc 12. calculate emc estimated value of operations

3. kendra enterprises has never paid a dividend. free cash flow is projected to be 80000 100000 and 106000 for the next 3years, respectively, after the third year, fcf is expected to grow at a constant rate of 10 percent. the company weighted average cost of capital is 15percent what is the value of operations?

Answer 1

1) As per CAPM

Required return = Risk free rate + ( Market required return - Risk free rate ) * Beta

Company A

Required return = 4.25% + ( 11% - 4.25% ) * 0.75

                       = 4.25% + 5.0625%

                       = 9.3125% Answer

Company B

Required return = 4.25% + ( 11% - 4.25% ) * 1.20

                       = 4.25% + 8.10%

                       = 12.35% Answer

Difference between A and B returns = 9.3125 - 12.35

                                                    = - 3.0375 Answer

2) Value of operations = Expected free cashflows / ( WACC - Growth rate )

                               = ( 400,000 * 1.05 ) / ( 0.12 - 0.05 )

                              = 420,000 / 0.07

                             = $ 6,000,000 Answer

3) Value of operations = FCF1 / ( 1 + WACC ) + FCF2 / ( 1 + WACC )² + FCF3 / ( 1 + WACC )³ + [ FCF₃ * (1+g)³(1+g1) / ( WACC - Growth rate ) * ( 1 + WACC )³ ]

                                = [ 80000 / 1.15 ] + [ 100000 / 1.15² ] + [ 106000 / 1.15³ ] + [ 106000 * 1.10 / 1.15³ * (0.15 - 0.10) ]

= 69565.22 + 75614.37 + 69696.72 + 1,533,327.85

= 1,748,204.16 Answer