FNCE30001 Chapter Notes - Chapter 13: Opportunity Cost, Public Company, Risk Premium

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orangemole587

29 Jun 2020

School

University of Melbourne

Department

Finance

Course

FNCE30001

Professor

Patrick Kelly

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Document Summary

The capm stipulates an opportunity cost of capital. Helps corporate managers determine whether to take a particular project. 3 inputs to estimate an appropriate capm expected rate of return for a project or firm. Firm or project beta with respect to the market. The capm states e(ri) = rf + bi(e(rm) - rf) (e(rm) - rf) = equity premium or market risk premium. The capm cost of capital in the present value formula: Expected rate of return = time premium + expected risk premium. Equity premium is the most difficult to estimate. Current predictive ratios - dividend or earnings yields. To estimate one benchmark required expected rate of return, use the treasury yield that has similar time (maturity or duration) to the project. To estimate multiple required expected rates of return, use different yields. Use yield with similar duration to the project for the rf at the start of the capm formula.

Related Questions

I have updated this with the appropriate Cost of Debt. Now my I would like to know if my WACC equation is correct?

Data for Hilton Group (HLT)

Equity: Market Cap 18.75 B *found on Yahoo Finance

Debt :

2016 - 10,641,000 *found on Yahoo Finance

2015 â 10,249,00 *found on Yahoo Finance **amount used in WACC calculation due to same number used in Cost of Debt

Annual Report 2015 figures â 9,821,000 *found in annual report â 10K

Risk-Free Rate: .72 *found on Yahoo Finance: Bond Center - 3 month Yield

Market Risk Premium: 5.5% *found in survey â http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2598104 / 7.6 average 1900 - 2004

Dividend Yield: Growth Rate 3.88% *Yahoo Finance, Analysist Estimates â next 5 years

Corporate Tax Rate: 35%

Cost of Equity using CAPM: E(R)= Rf + Beta (Expected Return on Market â Rf) = %

With Survey MRP =0.72+1.35*(5.5-0.72)= 7.173

With Average MRP =0.72+1.35*(7.6-0.72) = 10.08

Cost of Equity using Dividend Discount Model

= 3.88+.35 = 4.23

Cost of Debt:

Weighted Average Interest Rate â 4.2% *found on Hilton.com/quarterly results 2016/fourth quarter 2016 http://ir.hilton.com/~/media/Files/H/Hilton-Worldwide-IR-V3/quarterly-results/2016/q4-2016-earnings-release.pdf

WACC:

5.62% using CAPM cost of equity equation & survey market risk premium (5.5%)

7.43% using CAPM cost of equity equation & average MRP over years (7.6%)

brownsquirrel293

Blumberg Inc. has an unlevered beta of 1.10. The firm currently has no debt, but is considering changing its capital structure to be 40% debt and 60% equity. Its corporate tax rate is 40%, r(RF) = 5% and the market risk premium is 4%. What is Blumberg's cost of equity? (Hint: Use the Hamada Equation and CAPM) please show how you get the answer

		A. 10.76%
		B. 11.36%
		C. 10.56%
		D. 11.16%
		E. 10.96%

The Capital Asset Pricing Model (CAPM) is one of the most extensively tested models in finance. The following statements describe the assumptions, methods, and findings of several fo these studies. Based on your understanding of these issues, which of the following statements are true? Check all that apply:

A) Many studies of the CAPM have used (1) daily or monthly historical returns of the stocks and (2) the rate on both the 30-day US Treasury bill and the long-term US Treasury bond to estimate the risk-free rate (rRF)

B) Given it's assumptions, the CAPM has greater value as a predictive model than as a conceptual framework for the evaluation of risks and returns

C) Two important hypotheses addressed in tests of the CAPM and SML are that (1) the intercept on the vertical axis should equal the risk-free rate (rRF) and (2) the required return on a stock or portfolio exhibiting a beta of 1.0 should equal the required market return (rM)

D) In an examination of whether the betas portfolios of 10 or more randomly selected stocks are stable over time, Levy (1971) found that the betas of these portfolios are relatively stable, so historical betas are good estimators of future portfolio volatility

E) In theory, the CAPM should be applied to only stocks and not to other types of financial assets

Select the answers above that apply.

The many tests of the CAPM have concluded that the model is extremely useful in using ex post data to calculate true ex ante required returns. Is this statement accurate? Yes or No.

FNCE30001 Chapter Notes - Chapter 13: Opportunity Cost, Public Company, Risk Premium

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