AFM273 Lecture Notes - Lecture 12: Cash Flow, The Big Impression, Operating Leverage

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amaranthporcupine288

10 Oct 2017

School

University of Waterloo

Department

Accounting & Financial Management

Course

AFM273

Professor

Kenneth R Vetzal

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Document Summary

Afm273: chapter 12 estimating the cost of capital. Only 500 of the largest stocks: wilshire 5000 provides value-weighted index of all u. s stocks. 12. 3 the market risk premium: the (cid:373)a(cid:396)ket (cid:396)isk p(cid:396)e(cid:373)iu(cid:373) p(cid:396)o(cid:448)ides the (cid:271)e(cid:374)(cid:272)h(cid:373)a(cid:396)k (cid:271)(cid:455) (cid:449)hi(cid:272)h (cid:449)e a(cid:272)(cid:272)ess i(cid:374)(cid:448)esto(cid:396)"s (cid:449)illi(cid:374)g(cid:374)ess to hold market risk. Determining the risk-free interest rate: corresponds to the risk free rate at which investors can borrow and save, usually determined using the yields of canadian treasury bills and government of. Canada bonds: the vast majority of large firms use the yields of long-term bonds to determine the risk-free rate. Linear regression: the statistical technique that identifies the line of best git through a set of point: ((cid:1844) (cid:1870)(cid:3033))=(cid:2009)+(cid:2010)((cid:1844)(cid:3038)(cid:3047) (cid:1870)(cid:3033)), (cid:1831)[(cid:1844)]=(cid:1870)(cid:3033)+(cid:2010)(cid:4666)(cid:1831)[(cid:1844)(cid:3038)(cid:3047)] (cid:1870)(cid:3033)(cid:4667)+(cid:2009, first term is intercept or constant, the second term represents the sensitivity of the stock to market risk. Represents the deviation from the line of best fit and is zero on average.

Related Questions

a. Go to http://finance.yahoo.com and get the âMarket Capâ for AT&T (ticker: T). The market value of common equity (i.e., the market capitalization) is the stock price multiplied by the number of shares.

b. The appropriate component weights must be determined in order to calculate the WACC. Select âBalance Sheetâ from the column on the left and get the most recent âShort/Current Long Term Debtâ (this is the amount of debt due within one year) and âLong Term Debt.â Using these values, compute the weights for each of these three components of capital structure. (Notice that we are assuming that the short-term debt is a permanent component of capital structure rather than a temporary component used to finance working capital. In an ideal world, we would like to know the firmâs target weights. Because we donât know that, we would like the market values of the components. We have the market value of equity, but we only have the book values of debt. The book value of short-term debt should be close to its market value. Sometimes an analyst will estimate the market value of each long-term debt issue, but we will just use the book value of long-term debt for this Cyberproblem as an estimate of its market value.)

c. Next, view AT&Tâs âKey Statisticsâ and find its beta.

d. To estimate the component costs of capital, we need estimates of the 6-month risk-free rate (to be used in estimating the cost of short-term debt) and the 10-year risk-free rate (to be used in estimating the cost of long-term debt and the cost of equity). Go back to the home page (http://finance.yahoo.com), select Investing, and select Bonds. What are the yields on the 6-month and 10-year Treasury securities?

e. Apply the Capital Asset Pricing Model (CAPM) Security Market Line to estimate r_s for AT&T. Assume a market risk premium (r_m - r_RF) of 6.0%. Use the yield on a 10-year Treasury bond (found earlier in the problem) as an estimate of the risk-free rate.

f. We need an estimate of AT&T's cost of debt. First, find its bond rating. Go to http://www.moodys.com (you will have to register to search for AT&T, but it is free). At the top right, search for AT&T by its ticker symbol (T). Find the most recent bond rating by scrolling down to the âAnalyst Informationâ section. From http://bondchannel.bridge.com/publicspreads.cgi?Industrial, the appropriate yield spread needs to be found. For AT&T, get the shortest spread (probably 1 year) and the 10-year spread. (Note: Spreads are quoted in basis points, where 100 basis points equal 1 percentage point.) To estimate the cost of short-term debt, add the shortest spread to the 6-month yield on a Treasury security, found earlier (note: ideally, we would like the 6-month spread, but that is not reported, so we use the shortest reported spread). To estimate the cost of long-term debt, add the 10-year spread to the 10-year yield on a Treasury security.

g. Assume AT&T has an effective tax rate of 35% and using the component weights, the component costs, and the tax rate, estimate the weighted average cost of capital.

jadeherring641

The tendency of a stock's price to move up and down with themarket is reflected in its beta coefficient. Therefore, beta is ameasure of an investment's market risk, and is a key element of theCAPM. In this part of the project, you get financial informationusing Yahoo!Finance (found at http://finance.yahoo.com/ ) To find acompany's beta, enter the desired stock symbol and request a basicquote. Once you have the basic quote, select the "Key Statistics".Scroll down this page to find the stock's beta. In your initialresponse to the topic you have to answer all 5 questions. You areexpected to make your own contribution in a main topic as well asrespond with value added comments to at least two of yourclassmates as well as to your instructor. From Yahoo!Finance obtaina report on any two companies.

1.What are the betas listed for these companies?

2.If you made an equal dollar investment in each stocks whatwould be the beta of your portfolio?

3.If you made 70% of dollar investment in stock A, and 30% ofdollar investment in stock B, what would be the beta of yourportfolio? Please show your work.

4.Apply the Capital Asset Pricing Model (CAPM) Security MarketLine to estimate the required return on these two stocks.Assumptions and Data: Note that you will need the risk-free rateand the market risk premium. Assume a 5% market risk premium. Toget the current yield on 10-year Treasury securities go toFinance!Yahooâs (www.finance.yahoo.com) -click on Market Data -Bonds. You will use the current yield on 10-year Treasurysecurities as the risk-free rate to estimate the required rate ofreturn on stocks.

5.Compare the required return on these stocks calculated usingCAPM in question #4 against their historical return over the last52 weeks, found in the Yahoo!Finance - Key Statistics. Is there adifference between these returns? Is this a problem? Why is there adifference?

1. Last year, Logistics paid an annual dividend of $2.20 and announced that all future dividends would be $2.25 a share indefinitely. What is your required rate of return if you are willing to pay $15.25 a share for this stock?

14.50%

14.75%

16.07%

13.67%

13.88%

2. Which one of these factors generally has the greatest impact on a firmâs PE ratio?

depreciation method used by the firm

required rate of return

current dividends

the overall risk level of the current firm

future opportunities

3. When calculating the weighted average flotation cost, the weights should be based on the:

average amounts of external capital raised during the past twelve months.

firmâs target capital structure.

percentages of internal and external financing that will be used for the project.

firmâs current mix of debt and equity.

mix of debt and equity that will be used to finance the specific project.

4. The beta of a security is calculated as: (_____ of a securityâs return with the return on the market portfolio / _______).

Variance; Covariance of the security return

Covariance; Standard deviation of the market return

Covariance; Variance of the security return

Variance; Covariance of the market return

Covariance; Variance of the market return

5. A bond with a coupon rate of 6 percent that pays interest semiannually and is priced at par will have a market price of _____ and interest payments in the amount of _____ each.

$1,060; $30

$1,000; $60

$1,060; $60

$1,000; $30

$1,006; $60

6. The weighted average cost of capital for a firm is the:

maximum rate which the firm should require on any projects it undertakes.

overall rate which the firm must earn on its existing assets to maintain its value.

rate of return that the firm's preferred stockholders should expect to earn over the long term.

discount rate which the firm should apply to all of the projects it undertakes.

rate the firm should expect to pay on its next bond issue.

7. Jack's Construction Co. has 80,000 bonds outstanding that are selling at par value. Bonds with similar characteristics are yielding 8.6 percent. The company also has 4 million shares of common stock outstanding. The stock has a beta of 1.1 and sells for $40 a share. The U.S. Treasury bill is yielding 4 percent and the market risk premium is 8 percent. Jack's tax rate is 34 percent. What is Jack's weighted average cost of capital?

11.39%

10.65%

11.47%

10.43%

10.10%

8. Martin's Yachts is expected to pay annual dividends of $1.40, $1.75, and $2.00 a share over the next three years, respectively. After that, the dividend is expected to remain constant. What is the current value per share at a discount rate of 14 percent?

$13.39

$12.82

$12.22

$13.08

$13.57

AFM273 Lecture Notes - Lecture 12: Cash Flow, The Big Impression, Operating Leverage

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