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Assignment $5$: Attempt $1$

EFFICIENT CAPITAL MARKETS AND CAPITAL STRUCTURE

Angelina Corporation is a biotechnology company dedicated to molecules signaling and targeted antibody drugs. The company provides remedies for eye diseases, allergic and inflammatory diseases as well as cancer and metabolic diseases. The CEO of Angelina Corporation, Sara Brown, is meeting with the company's board of directors to discuss efficient capital markets and behavioral challenges and their impact on the company's stock and capital structure decisions. She explains that if capital markets are efficient, management cannot create value by fooling investors, and the market value of the company's stock reflects underlying intrinsic value. She added that stock prices reflect available information and that investors are rational and will analyze the available information and adjust their estimates of stock prices in a rational way. She stated that investors gather information from different sources including online resources, financial reports, the media, trade journals, economic reports etc. before making their investment decisions. She concluded that the share price of the company could be maximized only if the company is able to generate positive free cash flows now and in the future. A board member, Michael Burton, says that new research studies are emerging in behavioral finance that question the rationality of investors and market efficiency. Mr$.$ Burton explains that investors do not act rationally all the time in the investment decision$-$making process so the market cannot be efficient. He stated that results from various studies indicate that investors are prone to heuristics$-$driven biases such as loss aversion, overconfidence, regret, familiarity, conservatism, representativeness, and confirmation biases.

The following information on Angelina Corporation was gathered from

finance.yahoo.com, financial reports and other sources. Use this information to answer the following questions.

$$

Stock Statistics

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Assignment $5$: Attempt $1$

from

finance.yahoo.com, financial reports and other sources. Use this information to answer the following questions.

$\backslash$table$[[$Stock Statistics,$],[$Stock price per share,$$28],[$Volume of trading,$126,980],[$Beta$,1\mathrm{.}82],[$Earnings per share $($EPS$),$$$5\mathrm{.}00],[$Dividend per share $($DPS$),$$$2\mathrm{.}00],[$Price Earning $($PE$)$ ratio,$5\mathrm{.}60],[$Return on equity $($ROE$),18\mathrm{.}50\%],[$Financing components,$],[$Market value of equity,$60,000,000],[$Market value of debt,$40,000,000],[$Total market value,$100,000,000],[$Other information,$],[$Before$-$tax cost of debt,$5\mathrm{.}85\%],[$Corporate tax rate,$21\%],[$Market return,$12\mathrm{.}50\%],[$Risk free rate,$4\mathrm{.}50\%]]$

$1.)$ Calculate the following for Angelina Corporation:

i$.$ Market value weights for equity and debt

ii$.$ the cost of equity using CAPM

i$.$ the after$-$tax cost of debt

$2.)$ Calculate the following:

i$.$ weighted average cost of capital $($WACC$)$ for Angelina Corporation using market value weights.

ii$.$ the earnings growth rate for Angelina Corporation

$3.)$ What financing and investment decisions would Angelina Corporation make that require the use of WACC?

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Assignment $5$: Attempt $1$

$4.)$ Do the following:

i$.)$ Using the dividend discount model, what is the estimated stock price of Angelina Corporation's share if it has a zero$-$growth rate?

ii$.)$ Using the dividend discount model, what is the estimated stock price of Angelina Corporation's share if it has the growth rate calculated above $(2$ii$)?$

iii$).$ Calculate the cost of equity for the corporation for next year using the dividend discount model approach assuming that the stock price is $$30,$ dividend is $2\mathrm{.}47,$ and growth rate is $12\%$

$5.)$ Angelina Corporation wants to issue preferred stocks next year that will pay $$1\mathrm{.}85$ dividend per year indefinitely at a rate of return of $12\%.$ What should be the price of the preferred stock?

$6.)$ Angelina Corporation's stock price has risen steadily each day for the past $20$ days. Nar Gurung, an individual investor, believes that this trend will continue for a long time. He believes that he is a better investor than average and can earn excess returns from trading Angelina's stock. Last year, Nar missed an opportunity to earn excess returns from a Biotech company and he does not want to make that mistake again. He has therefore decided to invest heavily this year in Angelina Corporation to avoid any regret of making a second mistake. Nar has worked in the Biotech industry for over $25$ years and seem to know more about the industry. He believes that he can earn excess returns by investing in Biotech stocks. Most of his investment portfolio is in biotech companies.

i$.)$ Identify and explain four behavioral biases Nar Gurung is exhibiting.

ii$.)$ If the market is semistrong form efficient, can Nar Gurung reap excess returns from