Question

Stock	Beta	Expected returns
A	1.1	10.50%
B	0.8	7.80%
C	0.7	7.10%
D	1.3	12.20%
E	1.5	14.48%

Assume that there are two securities which are not correctly priced. Which are they? Are they over-priced or under-priced?   

b. Given the following information for Company D, find the WACC. Assume the company’s tax rate is 25 percent.

1. Debt: 5,600 (23) percent coupon bonds outstanding, $1,000 par value, 2 years to maturity, selling for 120 percent of par; the bonds make quarterly payments.
2. Common stock: 100,000 shares outstanding, selling for $36 per share; the beta is 1.2.
3. Preferred stock: 15,000 shares of 8 percent preferred stock outstanding (par value of $100), currently selling for $72 per share (par value of $100).
4. Market: 13 percent market returns and 3 percent risk-free rate.  

Answer 1

					beta* (market return-rf)
	Beta	Return	Risk free	Market	Expected return	Difference
A	1.1	10.50%	3%	13%	11.00%	-0.50%
B	0.8	7.80%	3%	13%	8.00%	-0.20%
C	0.7	7.10%	3%	13%	7.00%	0.10%
D	1.3	12.20%	3%	13%	13.00%	-0.80%
E	1.5	14.48%	3%	13%	15.00%	-0.52%

As per above, stock D & E have highest difference,The return caluclated are lower than expected therefore the stocks are undervalued

WACC
	Qty	Value	Market	Market Value	Weights
Debt	5600	1000	120%	67,20,000	0.589474
Stock	100000	36	100%	36,00,000	0.315789
Pref	15000	72	100%	10,80,000	0.094737
				1,14,00,000
	Calculation	%	Weights	%*Weights
Debt	23%	*	(1-0.25)	17.25%	0.589474	10.17%
Stock	1.2	(13%-3)	3%	15.0%	0.315789	4.74%
Pref			8%	8%	0.094737	0.76%
					WACC	15.66%

WACC is 15.66%