1. 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 $0.75 per share, growing by 2.8% per year. If EGO’s equity cost of capital is 9.1%, 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 | |
| |
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. (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. (Round to two decimal places.)
3. Given the data from the following table: (Question 3 data file Excel attachment) 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. (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.) . (Round to the nearest dollar.)
c. Do the same for small stocks.
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
nothing%.
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 $
nothing
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.)
4. Aluminum maker Alcoa has a beta of about 0.64, whereas Hormel Foods has a beta of 0.87. 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?
5. You need to estimate the equity cost of capital for XYZ Corp. You have the following data available regarding past returns:
Risk-free Return Market Return XYZ Return
2011 2% 7% 10%
2012 1% -31% -49%
a. What was XYZ’s average historical return?
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 4%, and you expect the market’s return to be 10%. 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 (a) because the average past returns provides a better estimate of expected returns.
B. Part (d) because the average past returns provides a better estimate of expected returns.
C. Part (d) because the CAPM provides a better estimate of expected returns.
D. Part (a) because the CAPM provides a better estimate of expected returns.
6. In mid-2012, Ralston Purina had AA-rated, 10-year bonds outstanding with a yield to maturity of 1.83%
a. What is the highest expected return these bonds could have? (Round to two decimal places.)
b. At the time, similar maturity Treasuries had a yield of 0.83%. 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 1.4% 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?
7. 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 0.87, the risk-free rate is 3%, and the market risk premium is 5%.
a. If your firm’s project is all-equity financed, estimate its cost of capital.
After computing the project’s cost of capital you decided to look for other comparables to reduce estimation error in your cost of capital estimate. You find a second firm, Thurbinar Design, which is also engaged in a similar line of business. Thurbinar has a stock price of $23 per share, with 15 million shares outstanding. It also has $111 million in outstanding debt, with a yield on the debt of 4.4%. Thurbinar’s equity beta is 1.00. 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. (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. (Round to two decimal places.)
d. Explain the difference between your estimate in part (b) and part (c). (Select the best choice below.)
A. 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.
B. The answers are actually the same; any difference is just due to rounding errors.
C. The answers differ because we are using approximations rather than formulas that hold exactly.
D. We should have gotten the same answer, the problem is the numbers in the problem are not consistent.
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.)
