• Correlation between Kellogg and Pepsi: 0.3
• Correlation between Kellogg and Albertson's: 0.5
• Correlation between Pepsi and Albertson's: 0.6
• Risk-free rate: 3%
• Expected return on the market: 12%
• Assume all debts in this question are risk-free
• The corporate tax rate is 34% for all firms in this question.

Business Equity Beta Standard Deviation Debt Equity Current Firm Value Current Stock Price

Kellogg Ready-to-eat 0.7 0.4 40% 60% $14 billion $33

cereals

Pepsi Food and beverage 1 0.5 30% 70% $87 billion $50

conglomerate

Albertson's Grocery stores 1.2 0.3 50% 50% $12 billion $30

Given the above information, please answer the following questions:

a) What would be the standard deviation of a portfolio with 50% of its money in Albertson's stock and 50% in Kellogg's stock?

b) For that portfolio described in part a), would replacing Kellogg with Pepsi increase or decrease the total risk of the portfolio? [No calculation needed, just explain]

c) If Albertson's is planning to pay a $1 per share dividend one year from now, what price is the market expecting it to be immediately after the dividend?

d) Let's say now Albertson's decided to permanently REDUCE its debt by $3 billion and replace it with $3 billion in new equity issue. The swap would have no effect on Albertson's project cash flows. What would the new value of Albertson's be after the exchange?

e) Let's say your company wants to buy Quaker Oats from Pepsi. Quaker Oats is a division of Pepsi that produces ready-to-eat cereals. What discount rate should you use to evaluate this investment? How much is this discount rate?