Key facts and assumptions concerning Wegman Company, at December 12, 2007, appear below Answer

1.
Asset X Asset Y
Value Value
Year Cash Flow Beginning Ending Cash Flow Beginning Ending
2000 1,000 20,000 22,000 1,500 20,000 20,000
2001 1,500 22,000 21,000 1,600 20,000 20,000
2002 1,400 21,000 24,000 1,700 20,000 21,000
2003 1,700 24,000 22,000 1,800 21,000 21,000
2004 1,900 22,000 23,000 1,900 21,000 22,000
2005 1,600 23,000 26,000 2,000 22,000 23,000
2006 1,700 26,000 25,000 2,100 23,000 23,000
2007 2,000 25,000 24,000 2,200 23,000 24,000
2008 2,100 24,000 27,000 2,300 24,000 25,000
2009 2,200 27,000 30,000 2,400 25,000 25,000

Beta (X) 1.60
Beta (Y) 1.00
Risk Free Rate 0.07
EMPR 0.05

a. Calculate the annual rate of return for each asset in each of the 10 preceding years, and use those values to find the average annual return for each asset over the 10-year period. b. Use the returns calculated in part a to find (1) the standard deviation and (2) the coefficient of variation of the returns for each asset over the 10-year period 2000-2009. c. c. Use your findings in parts a and b to evaluate and discuss the return and risk associated with each asset. Which asset appears to be preferable? Explain. d. Use the CAPM to find the required return for each asset. Compare this value with the average annual returns calculated in part a.
e. Compare and contrast your findings in parts c and d. What recommendations would you give Mary with regard to investing in either of the two assets? Explain to Mary why she is better off using beta rather than the standard deviation and coefficient of variation to assess the risk of each asset.

2. Key facts and assumptions concerning Wegman Company, at December 12, 2007, appear below. Using this information, answer the questions following.

Facts and Assumptions
Yield to maturity on long-term government bonds 4.54%
Yield to maturity on company long-term bonds 6.32%
Coupon rate on company long-term bonds 7.50%
Market price of risk, or excess return 6.30%
Estimated company equity beta 1.05
Stock price per share $25.97
Number of shares outstanding 681.2 million
Book value of equity $4,965 million
Book value of interest-bearing debt $6,674 million
Tax rate 35.0%
a) What is Wegman’s cost of equity?
b) What is Wegman’s WACC?

3. Firm Equity Beta Debt MV of Equity Tax Rate D/E Unlevered Beta
Slack & Mecker 1.19 4,100 6,300 35% 0.650793651 0.84
Gedders Corp 1.2 5 200 35% 0.025 1.18
Marie of Rome 2.14 380 530 35% 0.716981132 1.46
Dalton Inc. 3.25 375 115 35% 3.260869565 1.04
Hearlpool 1.83 10600 9,100 35% 1.164835165 1.04
Average 1.11

a) RM’s beta by relevering the estimated asset beta.
b) What concerns, if any, would you have about using the betas of these firms to estimate Rough Manufacturing’s asset beta?

Q4 “ABC Inc. is contemplating an average risk investment with an initial investment requirement of $40m and expected annual after tax cash flows of $6.4m in perpetuity.

a) What is the internal rate of return on the investment?
b) What is the weighted average cost of capital?
c) If undertaken, would you expect this investment to benefit shareholders?
Explain why or why not

ABC Inc. is contemplating an average risk investment with an initial investment requirement of $40m and expected annual after tax cash flows of $6.4m in perpetuity.

a) What is the internal rate of return on the investment?
b) What is the weighted average cost of capital?
c) If undertaken, would you expect this investment to benefit shareholders?
Explain why or why not

Q 5.

Facts and Assumptions
Yield to maturity on long-term government bonds 5.0%
Yield to maturity on company long-term bonds 7.0%
Market price of risk (EMRP) 6.9%
Estimated company and project asset beta 0.70
Stock price per share $60
Number of shares outstanding 2 million
Market value of interest-bearing debt outstanding 80 million
Tax rate 35.0%
Inflation rate 3.0%
Initial cost of investment $200 million
Year 1 selling price per unit $80
Year 1 variable manufacturing cost per unit $55
Year 1 general selling & administrative expenses $200 million
Expected project life 8 years
Salvage value 40 million
Depreciation schedule Straight-line
Working capital 20.0% as percent of sales
Year 0 1 2 3 4 5 6 7 8
Unit sales in millions – 2 10 20 23 24 23 22 15
a. Company equity beta
b. Cost of equity capital
c. Weighted-average cost of capital

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Key facts and assumptions concerning Wegman Company, at December 12, 2007 appear below Complete A+ Answer