Question 1

The total market value of company is 6million. Total value of debt is 4 million. Estimate of beta of
the stock is currently 1.5 and expected risk premium on market is 6%. The T-bill rate is 4%.Assume
that the company has taken a debt. The debt is risk-free. The tax rate is 35%.

What is expected return on equity of the company?

What is the cost of capital of the company?

What is an appropriate discount rate for an expansion of company’s current business?

Suppose the company decides to diversify into other business. The unleveraged beta of the other
business is 1.2. Estimate the return on company’s investment in the new business.

Question 2

Std Deviation of Equity Returns R-square Beta

Company A 13% 0.49 0.11
Company B 21% 0.01 0.25

The above data is for the respective equity of the company. What proportion of each stock’s risk was
market risk, and what proportion was specific risk? Using CAPM, what is expected return on Stock A?
Assume risk free interest rate to be 5% and expected market return to be 12%. If the return on
market, next year, is zero, what is your expected return on stock A and B?

Question 3

A firm has a capital structure as follows:

Security Beta Market Value

(in Rs millions)
Debt 0 100
Common Stock 1.2 299

What is firm’s asset beta and WACC? If the company scales up its operations (the expansion is
financed by an additional equity of 101mn), such that the assets remain of the same risk, what is an
appropriate discount rate that the company should use for its projects? Assume that the risk free
interest rate is 5% and market risk premium is 6%.

Question 4

Company A’s financing includes 5 million of bank loans. The common equity, as seen from the
annual report is 6.67 million. The shares outstanding of the stock of this firm are 500,000 with the
current trading price of the share on stock exchange as Rs. 18. Calculate the WACC of the company.
Assume the tax rate to be 35%, the beta of equity to be 0.8 and the risk free rate and equity market
risk premium to be 5% and 8% respectively.
Question 5

Part A –

Company A has surplus cash. Hence, it decides to pay Rs. 4 per share to investors by paying out a
regular dividend of Rs. 1 per quarter or Rs. 4 per year. The stock price, when this announcement is
made is Rs. 90. What happens to the price when the stock goes ex dividend?

Part B –

Assume that instead of dividend payment a stock repurchase is announced. What happens to the
stock price upon repurchase?

Question 6

Company B is a mature business, although it pays no cash dividends. Earnings forecasted for next
year are 56 million. The number of outstanding shares is 10 million. Company pays out 50% of
earnings by repurchases and reinvests the remaining earnings. With reinvestments, the company
has achieved a steady growth of 5% per year. Assume that the cost of equity is 12%.

Calculate the stock price of this company by discounting the stream of cash that the company
receives (use present value calculation).

Suppose that the company announces a switch from repurchases to regular cash dividend. The
dividend next year is Rs. 2.8 per share. The target payout ratio is still 50%. All future payouts will be
in the form of dividends. In this scenario, what is the stock price?

Question 7

Company X has 5000 shares outstanding and the stock price is Rs 140. The company is expected to
pay a dividend of Rs. 20 per share next year and thereafter the dividend is expected to grow
indefinitely by 5% a year. The company management makes a surprise announcement, wherein, the
company, henceforth, will distribute half the cash in the form of dividends and half in the form of
repurchases.

(a) What is the total value of the firm pre and post announcement? What is price per share?
(b) What is the stream of dividends that a shareholder who decides to retain his shares forever
is going to receive? Re-Calculate the share price by calculating the present value of all
dividend payments. Does this match with the answer in part (a.)?