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Financial Modeling

imon Benninga

Chapter 3

Calculating the Weighted Average Cost of Capital (WACC) - all with Video Answers

Educators

Chapter Questions

01:56

Problem 1

ABC Corp. has a stock price $P_0=50$. The firm has just paid a dividend of $$\$ 3$$ per share, and intelligent shareholders think that this dividend will grow by a rate of $5 \%$ per year. Use the Gordon dividend model to calculate the cost of equity of $\mathrm{ABC}$.

Narayan Hari
Narayan Hari
Numerade Educator
01:15

Problem 2

Unheardof, Inc., has just paid a dividend of $$\$ 5$$ per share. This dividend is anticipated to increase at a rate of $15 \%$ per year. If the cost of equity for Unheardof is $25 \%$, what should be the market value of a share of the company?

Anand Jangid
Anand Jangid
Numerade Educator
10:01

Problem 4

Dismal.Com is a producer of depressing Internet products. The company is currently not paying dividends, but its chief financial officer thinks that starting in 3 years it can pay a dividend of $$\$ 15$$ per share, and that this dividend will grow by $20 \%$ per year. Assuming that the cost of equity of Dismal.Com is $35 \%$, value a share based on the discounted dividends.
FIGURE CANT COPY
Use the Gordon model to calculate Chrysler's cost of equity at end 1996 on the basis of dividends only.

Lucas Finney
Lucas Finney
Numerade Educator
04:41

Problem 5

The current stock price of TransContinentalAirways is $$\$ 65$$ per share. TCA currently pays an annual per-share dividend of $$\$ 3$$. Over the past 5 years this dividend has grown annually at a rate of $23 \%$. A respected analyst assumes that the current growth rate of dividends will hold up for the next 5 years, after which dividend growth will slow to $5 \%$ annually. Use the twostagegordon function to compute the cost of equity.

Kaylee Mcclellan
Kaylee Mcclellan
Numerade Educator
10:01

Problem 6

ABC Corp. has just paid a dividend of $$\$ 3$$ per share. You-an experienced analyst-feel quite sure that the growth rate of the company's dividends over the next 10 years will be $15 \%$ per year. After 10 years you think that the company's dividend growth rate will slow to the industry average, which is about $5 \%$ per year. If the cost of equity for $\mathrm{ABC}$ is $12 \%$, what is the value today of one share of the company?

Lucas Finney
Lucas Finney
Numerade Educator

Problem 7

Consider a company which has $\beta_{\text {equily }}=1.5$ and $\beta_{\text {act }}=0.4$. Suppose that the risk-free rate of interest is $6 \%$, the expected return on the market $E\left(r_M\right)=15 \%$, and that the corporate $\operatorname{tax}$ rate is $40 \%$. If the company has $40 \%$ equity and $60 \%$ debt in its capital structure, calculate its weighted average cost of capital using both the classic CAPM and the taxadjusted CAPM.

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01:34

Problem 8

On the spreadsheet with this chapter you will find the following monthly data for Cisco's stock price and the S&P 500 index. Compute the equation $r_{C S C O, r}=\alpha_{\mathrm{CSCO}}+\beta_{\mathrm{CSCO}} r_{S p_1,}$ and include the $R^2$ and $t$-statistics for the equation and its coefficients.
FIGURE CANT COPY

Adriano Chikande
Adriano Chikande
Numerade Educator

Problem 9

9. You are considering buying the bonds of a very risky company. $A$ bond with a $$\$ 100$$ face value, a 1-year maturity, and a coupon rate of $22 \%$ is selling for $$\$ 95$$. You consider the probability that the company will actually survive to pay off the bond $80 \%$. With $20 \%$ probability, you think that the company will default, in which case you think that you will be able to recover $$\$ 40$$.
a. What is the expected return on the bond?
b. If the company has cost of equity $r_E=25 \%$, tax rate $T_C=35 \%$, and $40 \%$ of its capital structure is equity, what is its weighted average cost of capital (WACC)?

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Problem 10

It is 1 January 1997. Normal America, Inc. (NA) has paid a year-end dividend in each of the last 10 years, as shown by the table below:
FIGURE CANT COPY
a. Calculate NA's $\beta$ with respect to the $S \& P 500$.
b. Suppose that the Treasury bill rate is $5.5 \%$ and that the expected return on the market is $E\left(r_M\right)=13 \%$. If the corporate tax rate $T_C=35 \%$, calculate NA's cost of equity using both the classic CAPM and tax-adjusted model.
c. Assume that NA's cost of debt is $8 \%$. If the company is financed by $1 / 3$ equity and $2 / 3$ debt, what is its weighted average cost of capital using each of the two CAPM models?

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01:19

Problem 11

At the end of June 2007 , the price/earnings ratio of the S&P 500 was 17.5. Assume that the index proxies for the market, that it has a $50 \%$ dividend payout ratio, and that dividends are expected to grow at $7 \%$. Compute $E\left(r_M\right)$.

Kaylee Mcclellan
Kaylee Mcclellan
Numerade Educator
01:31

Problem 12

The template for exercise 12 gives the prices of the Vanguard Index 500 Fund (symbol: VFINX). This fund's prices replicate the S&P 500 with dividends reinvested. Use these data to estimate the expected return on the S&P 500 in two variations: All the data, the last 2 years. (This exercise shows the problematics of using historical market data to estimate the expected returns.)

Breanna Ollech
Breanna Ollech
Numerade Educator
01:56

Problem 13

Suppose that the S\&P 500 price/earnings ratio is 17.5 , the dividend payout ratio of the $S \& P$ is $50 \%$, and that you estimate a future growth of dividends of $7 \%$. What is $E\left(r_M\right)$ ?
FIGURE CANT COPY

Narayan Hari
Narayan Hari
Numerade Educator
02:17

Problem 14

The template for exercise 14 gives the 10-year history of Intel's quarterly dividends. Compute Intel's cost of equity $r_E$ using the Gordon dividend model. Compare the cost of equity computed on the basis of 10 years of growth with that computed on the last 5 years of growth.

Akash M
Akash M
Numerade Educator