UNIT III ASSESSMENT
Bholman22
unit_iii_assessment__finance_.docx1. Canadian-based mining company El Dorado Gold (EGO) suspended its dividend in March 2016 as a result of declining gold prices and delays in obtaining permits for its mines in Greece. Suppose you expect EGO to resume paying annual dividends in two years’ time, with a dividend of $0.35 per share, growing by 2.9% per year. If EGO’s equity cost of capital is 9.5%, what is the value of a share of EGO today?
The value of a share of EGO today is $ . (Round to the nearest cent.)
2. Heavy Metal Corporation is expected to generate the following free cash flows over the next five years:
|
Year |
1 |
2 |
3 |
4 |
5 |
|
FCF ($ million) |
53.053.0 |
68.068.0 |
78.078.0 |
75.075.0 |
82.082.0 |
|
(Click on the icon located on the top-right corner of the data table in order to copy its contents into a spreadsheet.) |
After that, the free cash flows are expected to grow at the industry average of 4.0% per year. Using the discounted free cash flow model and a weighted average cost of capital of 14.0%:
a. Estimate the enterprise value of Heavy Metal.
The enterprise value will be $ million. (Round to two decimal places.)
b. If Heavy Metal has no excess cash, debt of $300 million, and 40 million shares outstanding, estimate its share price.
The stock price per share will be $ . (Round to two decimal places.)
3. Given the data from the following table: ( SEE ATTACHED SPREADSHEET ) What if the period from 1990 to 2014 had been "normal"?
a. Calculate the arithmetic average return on the S&P 500 from 1926 to 1989.
The arithmetic average return of the S&P 500 from 1926 to 1989 is %.
(Round to two decimal places.)
b. Replace the actual returns from 1990 to 2014 with the average return from (a).
How much would $100 invested in the S&P 500 at the end of 1925 have grown to by the end of 2014? (Hint: Use the actual returns from 1926 to 1989 and then continue the growth at the assumed rate.)
$100 invested in the S&P 500 at the end of 1925 would have grown to $ .(Round to the nearest dollar.)
c. Do the same for small stocks.
The arithmetic average return of the small stocks from 1926 to 1989 is %. (Round to two decimal places.)
$100 invested in the small stocks at the end of 1925 would have grown to $ .(Round to the nearest dollar.)
4. Consider two local banks. Bank A has 100 loans outstanding, each for $1.0 million, that it expects will be repaid today. Each loan has a 5% probability of default, in which case the bank is not repaid anything. The chance of default is independent across all the loans. Bank B has only one loan of $100 million outstanding, which it also expects will be repaid today. It also has a 5% probability of not being repaid. Which bank faces less risk? Why?
A. The expected payoffs are the same, but Bank A is riskier. I prefer Bank B.
B. The expected payoffs are the same, but Bank A is less risky. I prefer Bank A.
C. The expected payoff is higher for Bank A, but is riskier. I prefer Bank B.
D. In both cases the expected loan payoff is the same: $ 100 million times 0.95 equals $ 95.0 million$100 million×0.95=$95.0 million. Consequently, I don't care which bank I own
5. Consider the following two, completely separate, economies. The expected return and volatility of all stocks in both economies is the same. In the first economy, all stocks move together—in good times all prices go up together and in bad times they all fall together. In the second economy, stock returns are independent—one stock increasing in price has no effect on the prices of other stocks. Assuming you are risk-averse and you could choose one of the two economies in which to invest, which one would you choose? Explain.
A. A risk-averse investor would choose the economy in which stocks move together because the uncertainty is much more predictable, and you have to predict only one thing.
B. A risk-averse investor would prefer the economy in which stock returns are independent because by combining the stocks into a portfolio he or she can get a higher expected return than in the economy in which all stocks move together.
C. A risk-averse investor would choose the economy in which stock returns are independent because risk can be diversified away in a large portfolio.
D. A risk-averse investor is indifferent in both cases because he or she faces unpredictable risk
6. There are two ways to calculate the expected return of a portfolio: either calculate the expected return using the value and dividend stream of the portfolio as a whole, or calculate the weighted average of the expected returns of the individual stocks that make up the portfolio. Which return is higher?
A. The weighted average expected return of the individual stocks is higher because returns are convex.
B. Neither—both calculations give the same answer.
C. Impossible to tell, it depends on the portfolio.
D. The weighted average expected return of the individual stocks is higher because returns are concave.
7. Using the data in the following table ( SEE ATTACHED SPREADSHEET ) what is the covariance between the stocks of Southwest Airlines and General MillsSouthwest Airlines and General Mills?
The covariance between the stocks of
Southwest Airlines and General MillsSouthwest Airlines and General Mills is .(Round to three decimal places.)
8. Suppose Ford Motor stock has an expected return of 18% and a volatility of 38%, and Molson Coors Brewing has an expected return of 12% and a volatility of 31%. If the two stocks are uncorrelated
a. What is the expected return and volatility of a portfolio of 80% Ford Motor stock and 20% of Molson Coors Brewing stock?
The expected return of the portfolio is %. (Round to two decimal places.)
The volatility of the portfolio is %. (Round to two decimal places.)
b. Given your answer to
(a),
is investing all of your money in Molson Coors stock an efficient portfolio of these two stocks? (Select the best choice below.)
A .No.
B. Yes.
C .Cannot determine from the given information
c. Is investing all of your money in Ford Motor an efficient portfolio of these two stocks? (Select the best choice below.)
A. Yes.
B. No.
C. Cannot determine from the given information
9. Aluminum maker Alcoa has a beta of about 0.47, whereas Hormel Foods has a beta of 0.56.
If the expected excess return of the market portfolio is 5%, which of these firms has a higher equity cost of capital, and how much higher is it?
The firm that has the higher equity cost of capital is
▼
Hormel Foods
Alcoa
by %. (Select from the drop-down menu and round to two decimal places.)
10. You need to estimate the equity cost of capital for XYZ Corp. You have the following data available regarding past returns: ( SEE ATTACHED SPREADSHEET )
a. What was XYZ's average historical return?
XYZ's average historical return was %. (Round to one decimal place.)
b. Compute the market's and XYZ's excess returns for each year.
The market's excess return for 2011 was %. (Round to the nearest integer.)
The market's excess return for 2012 was %. (Round to the nearest integer.)
XYZ's excess return for 2011 was %. (Round to the nearest integer.)
XYZ's excess return for 2012 was %. (Round to the nearest integer.)
Estimate XYZ's beta.
XYZ's beta is . (Round to two decimal places.)
c. Estimate XYZ's historical alpha.
XYZ's historical alpha was %. (Round to one decimal place.)
d. Suppose the current risk-free rate is 3%, and you expect the market's return to be 9%.
Use the CAPM to estimate an expected return for XYZ Corp.'s stock.
The expected return for XYZ Corp.'s stock was %. (Round to two decimal places.)
e. Would you base your estimate of XYZ's equity cost of capital on your answer in part
(a) or in part (d)? (Select the best choice below.)
A. Part (d) because the average past returns provides a better estimate of expected returns.
B. Part (d) because the CAPM provides a better estimate of expected returns.
C. Part (a) because the average past returns provides a better estimate of expected returns.
D. Part (a) because the CAPM provides a better estimate of expected returns
11. In mid-2012, Ralston Purina had AA-rated, 10-year bonds outstanding with a yield to maturity of
2.32%.
a. What is the highest expected return these bonds could have? The highest expected return these bonds could have is %. (Round to two decimal places.)
b. At the time, similar maturity Treasuries had a yield of 1.32%.
Could these bonds actually have an expected return equal to your answer in part (a)? (Select the best choice below.)
A. No, if the bonds are risk-free, the expected return equals the risk-free rate, and if they are not risk-free the expected return is less than the yield.
B. Yes, if the bonds are risky enough, that is if the probability of default is high enough.
C. Yes, the yield to maturity is the maximum expected return you can expect.
D. Yes, because the reasons given in both A. and B. are true.
c. If you believe Ralston Purina's bonds have 1.5% chance of default per year, and that expected loss rate in the event of default is 52%, what is your estimate of the expected return for these bonds?
The estimated expected return for these bonds will be %. (Round to two decimal places.).
12. Your firm is planning to invest in an automated packaging plant. Harburtin Industries is an all-equity firm that specializes in this business. Suppose Harburtin's equity beta is 0.89, the risk-free rate is 3%, and the market risk premium is 6%
a. If your firm's project is all-equity financed, estimate its cost of capital.
The project's cost of capital is %. (Round to two decimal places.)
b. Assume Thurbinar's debt has a beta of zero. Estimate Thurbinar's unlevered beta. Use the unlevered beta and the CAPM to estimate Thurbinar's unlevered cost of capital
Thurbinar's unlevered beta is .(Round to two decimal places.)
Thurbinar's unlevered cost of capital is %. (Round to two decimal places.)
c. Estimate Thurbinar's equity cost of capital using the CAPM. Then assume its debt cost of capital equals its yield and using these results, estimate Thurbinar's unlevered cost of capital.
Thurbinar's equity cost of capital is %. (Round to two decimal places.)
Thurbinar's unlevered cost of capital is %. (Round to two decimal places.)
A. The answers differ because we are using approximations rather than formulas that hold exactly.
B. The answers are actually the same; any difference is just due to rounding errors.
C. We should have gotten the same answer, the problem is the numbers in the problem are not consistent.
D. In the first case, we assumed the debt had a beta of zero so we assumed the cost of debt was the riskless rate, while in the second case we assumed the cost of debt was the yield on debt.
e. You decide to average your results in part (b) and part (c), and then average this result with your estimate from part (a). What is your estimate for the cost of capital of your firm's project?
The average unlevered cost of capital from part (b) and part (c) is %.
(Round to two decimal places.)
The average unlevered cost of capital from part (b) and part (c) with part (a) is %.
(Round to two decimal places.)
