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Use the information for the question(s) below.
You are evaluating a new project and need an estimate for your project's beta. You have identified the following information
about three firms with comparable projects:
Firm
Name
Equity
Beta
Debt
Beta
Debt to
Equity Ratio
Lincoln 1.25 00.25
Blinkin 1.6 0.2 1
Nod 2.3 0.3 1.5
72)
Based upon the three comparable firms, what asset beta would you recommend using for your firm's new
project?
Use the information for the question(s) below.
Rockwood Enterprises is currently an all equity firm and has just announced plans to expand their current business. In order
to fund this expansion, Rockwood will need to raise $100 million in new capital. After the expansion, Rockwood is expected
to produce earnings before interest and taxes of $50 million per year in perpetuity. Rockwood has already announced the
planned expansion, but has not yet determined how best to fund the expansion. Rockwood currently has 16 million shares
outstanding and following the expansion announcement these shares are trading at $25 per share. Rockwood has the ability
to borrow at a rate of 5% or to issue new equity at $25 per share.
73)
Show mathematically that the stock price of Rockwood does not depend on whether they issue new stock or
borrow to fund their expansion.
Use the information for the question(s) below.
Consider two firms: firm Without has no debt, and firm With has debt of $10,000 on which it pays interest of 5% per year.
Both companies have identical projects that generate free cash flows of $1000 or $2000 each year. Suppose that there are no
taxes, and after paying any interest on debt, both companies use all remaining cash free cash flows to pay dividends each
year.
74)
Fill in the table below showing the payments debt and equity holders of each firm will receive given each of the
two possible levels of free cash flows:
Without With
Free Cash
Flow
Interest
Payments
Equity
Dividends
Interest
Payments
Equity
Dividends
1000
2000
Use the information for the question(s) below.
Consider a project with free cash flows in one year of $90,000 in a weak economy or $117,000 in a strong economy, with each
outcome being equally likely. The initial investment required for the project is $80,000, and the project's cost of capital is
15%. The risk-free interest rate is 5%.
75)
Suppose that to raise the funds for the initial investment the firm borrows $45,000 at the risk free rate and issues
new equity to cover the remainder. In this situation, calculate the value of the firm's levered equity from the
project. What is the cost of capital for the firm's levered equity?
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76)
Two separate firms are considering investing in this project. Firm unlevered plans to fund the entire $80,000
investment using equity, while firm levered plans to borrow $45,000 at the risk-free rate and use equity to
finance the remainder of the initial investment. Calculate the expected returns for both the levered and
unlevered firm.
Answer Key
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