For the last few years, you have been running StoreWell, a company supplying refrigerants to storage...

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For the last few years, you have been running StoreWell, a company supplying refrigerants to storage and logistics clients. Given the market shifts during COVID-19. you decide to divert some of your chemical manufacturing plants to produce hand sanitizer. Your finance team has put together estimates of the annual free cash flows from the new venture, which you think are quite accurate. You are less sure about the cost of capital assumptions from your finance team and decide to estimate the cost of capital yourself. You compile the following information that you think may be useful: •The risk free rate is ry = 1.5% per year and the expected return on the market index, which is very well-diversified and a good approximation of the overall market portfolio, is E(M)=8% per year. The annual standard deviation of the return on the market portfolio is om = 20%. You can assume that the CAPM holds. • Your closest competitor is KeepFresh, which also produces refrigerants for the same market. Another competitor, Cool&Clean, has already diversified into producing hand sanitizer. Here is a summary of your and your competitors' setup up to this poijnt: % business in % business in refrigerants hand sanitizer 100% 0% 0% 50% Equity 3D BE GE 70% 0.2 1.6 35% Debt StoreWell (your firm) 30% KeepFresh 0% Cool&Clean 20% (a) (6 points) What are the asset betas of the three firms? (b) (8 points) What is your best estimate of the cost of capital of your new hand sanitizer division? (e) (6 points) In the end, you decide to spin off your hand sanitizer venture as a separate business, all equity financed. You are planning to issue 200K shares, and your earnings this year (t =0) are 81M. Based on the forecasts from your finance team, you expect your earnings to grow at 3% per year, and you will pay out 60% of your earnings in dividends. What should be the total valuation of your new hand sanitizer firm? 100% 01.3 40% 100% 80% 0.1 1.2 30% 50% (d) (6 points) Joe decides to invest his individual trading account into a portfolio that is 25% in KeepFresh stock and 75% in Cool&Clean stock. You estimate that the correlation between these two stocks is p=0.5. (d,1) What is the expected return on Joe's portfolio? (3 points) One of Joe's classmates from MBA203 suggests that the portfolio in part (d) may not be the most prudent way to invest his money. What do you think? Joe is not afraid to take on risk and is willing to take on the standard deviation computed in c.2. He would like the highest possible return. How would you advise him to invest? Please list the exact investment. (3 points) Ann would also like to invest her retirement savings, but instead of targeting a specific level of risk like Joe, she wants to minimize her risk, subject to achieving an expected return of at least 8% per year. What would you advise her to do? Please list the exact investment. For the last few years, you have been running StoreWell, a company supplying refrigerants to storage and logistics clients. Given the market shifts during COVID-19. you decide to divert some of your chemical manufacturing plants to produce hand sanitizer. Your finance team has put together estimates of the annual free cash flows from the new venture, which you think are quite accurate. You are less sure about the cost of capital assumptions from your finance team and decide to estimate the cost of capital yourself. You compile the following information that you think may be useful: •The risk free rate is ry = 1.5% per year and the expected return on the market index, which is very well-diversified and a good approximation of the overall market portfolio, is E(M)=8% per year. The annual standard deviation of the return on the market portfolio is om = 20%. You can assume that the CAPM holds. • Your closest competitor is KeepFresh, which also produces refrigerants for the same market. Another competitor, Cool&Clean, has already diversified into producing hand sanitizer. Here is a summary of your and your competitors' setup up to this poijnt: % business in % business in refrigerants hand sanitizer 100% 0% 0% 50% Equity 3D BE GE 70% 0.2 1.6 35% Debt StoreWell (your firm) 30% KeepFresh 0% Cool&Clean 20% (a) (6 points) What are the asset betas of the three firms? (b) (8 points) What is your best estimate of the cost of capital of your new hand sanitizer division? (e) (6 points) In the end, you decide to spin off your hand sanitizer venture as a separate business, all equity financed. You are planning to issue 200K shares, and your earnings this year (t =0) are 81M. Based on the forecasts from your finance team, you expect your earnings to grow at 3% per year, and you will pay out 60% of your earnings in dividends. What should be the total valuation of your new hand sanitizer firm? 100% 01.3 40% 100% 80% 0.1 1.2 30% 50% (d) (6 points) Joe decides to invest his individual trading account into a portfolio that is 25% in KeepFresh stock and 75% in Cool&Clean stock. You estimate that the correlation between these two stocks is p=0.5. (d,1) What is the expected return on Joe's portfolio? (3 points) One of Joe's classmates from MBA203 suggests that the portfolio in part (d) may not be the most prudent way to invest his money. What do you think? Joe is not afraid to take on risk and is willing to take on the standard deviation computed in c.2. He would like the highest possible return. How would you advise him to invest? Please list the exact investment. (3 points) Ann would also like to invest her retirement savings, but instead of targeting a specific level of risk like Joe, she wants to minimize her risk, subject to achieving an expected return of at least 8% per year. What would you advise her to do? Please list the exact investment.

Answer rating: 100% (QA)

SOLUTION a The asset betas of the three firms can be calculated using the CAPM formula betan Rn Rf RM Rf where Rn is the expected return on the asset Rf is the riskfree rate and RM is the expected ret... View the full answer