Financial Analysis Spreadsheet Templates

MAIN MENU -- CHAPTER 12

Problem 12-5 Problem 12-13
Corporate Finance by Ross, Westerfield, and Jaffe -- Seventh Edition Copyright 2005 Irwin/McGraw-Hill and KMT Software, Inc. (www.kmt.com)

Problem 12-8

Problem 12-11

Copyright 2005 Irwin/McGraw-Hill

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Corporate Finance
Ross, Westerfield, and Jaffe -- Seventh Edition
Problem 12-5 Objective Calculate and evaluate a stock's beta. Student Name: Course Name: Student ID: Course Number: The returns from the past 12 quarters on Mercantile Bank Corporation and the market are listed below. Mercantile -0.009 0.051 -0.001 -0.045 0.085 0.000 -0.080 0.020 0.125 0.110 -0.100 0.040 Market 0.023 0.058 -0.020 -0.050 0.071 0.012 -0.075 0.050 0.120 0.049 -0.030 0.028

The covariance of Mercantile Corporation's return with the market's return is 0.038711. The market variance is .038588. The expected returns on Mercantile and the market are 0.016333 and 0.019667, respectively. a. What is the beta of Mercantile Bank Corporation stock? b. Is Mercantile's beta higher or lower than the beta of the average stock?

Solution
Problem 12-5 Instructions a. What is the beta of Mercantile Bank Corporation stock? Covariance of Mercantile Corporation's return with the market's return Market varianace Mercantile's expected return Market expected return Beta for Mercantile Bank Corporation 1.003187519 0.038711 0.038588 0.016333 0.019667

b. Is Mercantile's beta higher or lower than the beta of the average stock? The beta of the average stock is one. Since Mercantile's beta is close to one, its stock has approximately the same risk as the overall market.

Copyright 2005 Irwin/McGraw-Hill

FAST Workbooks by Ross, Westerfield, and Jaff

Problem: 12-5

Corporate Finance
Ross, Westerfield, and Jaffe -- Seventh Edition
Problem 12-8 Objective Calculate the beta of debt and equity. Student Name: Course Name: Student ID: Course Number: The following table lists possible rates of return on Compton Technology's stock and debt, and on the market portfolio. The probability of each state is also listed. Return on Equity (%) 3% 8% 20% 15% Return on Debt (%) 8% 8% 10% 10% Return on the Market (%) 5% 10% 15% 20%

State 1 2 3 4

Probability 0.1 0.3 0.4 0.2

a. What is the beta of Compton Technology debt? b. What is the beta of Compton Technology stock? c. If the debt-to-equity ratio of Compton Technology is .5, what is the asset beta of Compton Technology?

Solution
Problem 12-8 Instructions Use formulas to calculate the requirements of this problem. You should begin by calculating the expected returns of the stock, debt and market and then move on to calculate the covariances of returns for the stock and market and the debt and the market. a. What is the beta of Compton Technology debt? Calculate expected returns Stock Debt Market 13.7% 9.2% 13.5%

Calculate the covariance of returns for the stock and the market and the debt and the market. Stock and Market State 1 2 3 4 Cov(RS,RM) Bond and Market State 1 2 3 4 Cov(Rb,RM) Variance of the market a. Beta of debt 0.188 Return on Debt (%) 8% 8% 10% 10% 0.000380 0.002025 (Debt) Deviation -1.2% -1.2% 0.8% 0.8% Return on the Market (%) 5% 10% 15% 20% (Market) Deviation -8.5% -3.5% 1.5% 6.5% Probability 0.1 0.3 0.4 0.2 Return on Equity (%) 3% 8% 20% 15% 0.002055 Deviation -10.7% -5.7% 6.3% 1.3% Return on the Market (%) 5% 10% 15% 20% Deviation -8.5% -3.5% 1.5% 6.5% Probability 0.1 0.3 0.4 0.2

b. What is the beta of Compton Technology stock? Beta of stock 1.015

c. If the debt-to-equity ratio of Compton Technology is .5, what is the asset beta of Compton Technology? Weights 66.7% 33.3% 100.0% 0.74 Beta 1.01 0.19

Stock Debt Asset beta

Copyright 2005 Irwin/McGraw-Hill

FAST Workbooks by Ross, Westerfield, and Jaffe

Problem: 12-8

Corporate Finance
Ross, Westerfield, and Jaffe -- Seventh Edition
Problem 12-11 Objective Calculate cost of equity and cost of capital Student Name: Course Name: Student ID: Course Number: Lizpaz Inc. is a levered firm with a debt-to-equity ratio of .25. The beta of the common stock is 1.15, while the beta of the debt is 0.3. The market-risk premium is 10 percent and the risk-free rate is 6 percent. The corporate tax rate is 35 percent. a. What is the firm's cost of equity capital? b. If a new company project has the same risk as the overall firm, what is the weighted average cost of capital for the project?

Solution
Problem 12-11 Instructions Enter formulas to calculate the requirements of this problem. a. What is the firm's cost of equity capital? Assumptions Debt-to-equity ratio Beta of common Beta of debt Market risk premium Risk-free rate Corporate tax rate Cost of equity

0.25 1.15 0.3 10% 6% 35% 17.5%

b. If a new company project has the same risk as the overall firm, what is the weighted average cost of capital for the project? Cost of debt Weight of equity Weight of debt Weighted average cost of capital 9.0% 80.0% 20.0% 15.2%

Copyright 2005 Irwin/McGraw-Hill

FAST Workbooks by Ross, Westerfield, and Jaffe

Problem: 12-11

Corporate Finance
Ross, Westerfield, and Jaffe -- Seventh Edition
Problem 12-13 Objective Calculate weighted average cost of capital Student Name: Course Name: Student ID: Course Number: Calculate the weighted average cost of capital for the Luxury Porcelain Company. The book value of Luxury's outstanding debt is $50 million. Currently, the debt is trading at 120 percent of book value and is priced to yield 12 percent. The 5 million outstanding shares of Luxury stock are trading at $20 per share. The required return on Luxury stock is 18 percent. The tax rate is 25 percent.

Solution
Problem 12-13 Instructions Calculate the weighted average cost of capital by enter formulas below. Assumptions Book value of debt Market value of debt Current yield on debt Common shares outstanding Stock price per share Required return on stock Tax rate

$60,000,000 $72,000,000 12% 5,000,000 $20 18% 25%

Weighted Average Cost of Capital Value of the firm $172,000,000 Weight of debt 41.9% Weight of stock 58.1% Weighted average cost 14.23%

Copyright 2005 Irwin/McGraw-Hill

FAST Workbooks by Ross, Westerfield, and Jaffe

Problem: 12-13