1 / 20

Managerial Finance Week 5 Class Exercises

Managerial Finance Week 5 Class Exercises. OVU- ADVANCE David Hamm, MBA, CPA January 2006 +. Chapter 13 case—Slide 1. You are considering a portfolio of three stocks Raeder (RMP) Boom=16% Avg=10% Bust=5% Yamamoto (YEC) Boom=24% Avg=13% Bust=-2% King (KCT) Boom=7% Avg 8.5% Bust=16%

louise
Télécharger la présentation

Managerial Finance Week 5 Class Exercises

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. Managerial FinanceWeek 5 Class Exercises OVU-ADVANCE David Hamm, MBA, CPA January 2006 +

  2. Chapter 13 case—Slide 1 • You are considering a portfolio of three stocks • Raeder (RMP) Boom=16% Avg=10% Bust=5% • Yamamoto (YEC) Boom=24% Avg=13% Bust=-2% • King (KCT) Boom=7% Avg 8.5% Bust=16% • Probability of boom market= 25% • Probability of average returns=50% • Probability of bust market=25%

  3. Expected Returns (Wt. Average) • Raeder (RMP): • Boom: 25% x 16% return = .04 • Avg: 50% x 10% return = .05 • Bust: 25% x 5% return = .0125 • Totals: .1025 or 10.25% • Yamamoto (YEC): • Boom: 25% x 24% return = .06 • Avg: 50% x 13% return = .065 • Bust: 25% x -2% return = -.005 • Totals: .120 or 12%

  4. Expected Return (Wt. Avg. )-2 • King (KCT) • Boom: 25% x 7% return = .0175 • Avg: 50% x 8.5% return= .0425 • Bust: 25% x 16% return = .04 • Totals .1000 or 10%

  5. Uncle Fred’s Bequest • Dear departed Uncle Fred leaves you $150K which you invest as follows: • RMP $45K • YEC $60K • KCT $45K • Calculate the “weighting” of the three stocks in your new portfolio • Solution: RMP & KCT: 45/150 =30% • Solution: YEC: 60/150 = 40% Note: total % must equal 100%

  6. Portfolio Expected Return • RMP: 30% x 10.25% =3.075% • YEC: 40% x 12.0 % = 4.800% • KCT: 30% x 10.0% = 3.000% • Total E(R) portfolio = 10.875% • Risk premium, if risk free rate is 4%: • 10.875% - 4% = 6.875%

  7. Portfolio Beta • If β (RMP) = 1.0; Β (YEC) = 1.5; and β (KCT) =.75 • Portfolio beta: • RMP 30% x 1.0 = .3 • YEC 40% x 1.5 = .6 • KCT 30% x .75 = .225 • β (portfolio) = 1.125

  8. CAPM for Raeder • CAPM = Rf + (Rm –Rf) x β asset • E(R) = 4% +(10% - 4%) x 1.0 • E(R) = 4 % + (6% x 1.0) • E(R) RMP = 10% • Note: at a beta of 1.0, Raeder would follow the market expected return of 10%

  9. CAPM for Yamamoto • CAPM = Rf + (Rm –Rf) x β asset • E(R) = 4% + (10%-4%) x 1.5 • E(R) = 4 % + (6% x 1.5) • E(R) = 4% + 9% • E(R) YEC= 13% • Note: at a beta of 1.5, Yamamoto would exceed the market expected return of 10%

  10. CAPM for King • CAPM = Rf + (Rm –Rf) x β asset • E(R) = 4% + (10%-4%) x .75 • E(R) = 4 % + (6% x .75) • E(R) = 4% + 4.5% • E(R) KCT= 8.5% • Note: at a beta of .75, King would be below the market expected return of 10%

  11. Stop for Chapter 15 notes

  12. Introducing MIC • Military Industrial Complex, Inc (MIC): • 2.5 MM shares outstanding @ $40 mkt price • Debt: $30MM trading at 95% of face • Beta= 1.30 Tax Rate = 40% • Market rates: Rm=10% Rf=4% risk premium=6% (Rm-Rf)

  13. CAPM for MIC • RE = Rf + (Rm –Rf) x β asset • RE =4% + (6% x 1.3) • RE = 4% + 7.8% • RE = 11.8% • We need this figure for the return on equity figure for the WACC calculation

  14. Equity & Debt in MIC portfolio • Equity valuation (at market): • 2.5 MM shares x $40 = $100 MM • Debt valuation (at market) • $30 MM x 95% = $28.5 MM • Weighting of equity & debt %: • Equity % = 100.0 MM or .778 (77.8%) • Debt % = 28.5 MM or .222 (22.2%) • Total % = 128.5 MM 100.0%

  15. WACC for MIC • WACC = [(E/V) x RE] + [D/V) x RD x 1-TC] • WACC= (.778 x .118)+ (.222 x .10 x .6) • WACC= .0918 + .0133 • WACC= .1051 or 10.51% • This is MIC’s required earnings rate (cost of capital) given its beta and the fact that 40% of its debt cost can be deducted for income tax purposes

  16. Stop for Chapter 17 notes

  17. MIC and Leverage possibilities • MIC has started a new subsidiary (MIC-2) to make a $50MM investment. • Assume “cost plus” arrangement with DoD will guarantee a 20% EBIT ($10MM yr) • MIC has already capitalized 50% of investment with 1 MM shares @ $25 each • It could raise another 1 MM shares or borrow $25MM at 10% • What should MIC-2 do?

  18. Zero vs 50% leverage (at 20% EBIT) ROE and EPS based on $25 MM equity at 50% leverage (1 MM shares) vs $50 MM equity or 2 MM shares at 100% equity

  19. Zero vs 50% leverage (at 10% EBIT) All equity 50% At 10% return the bottom line is “indifferent” and therefore probably not worth the risk of financial distress to borrow 50%

  20. Zero vs 50% leverage (at 8% EBIT) All equity 50% At a rate of return below borrowing costs, the firm would incur a “loss” to utilize debt leverage.

More Related