Question 04.

Data Case for Chapter 12: Estimating the Cost of Capital

You work in Walt Disney Company's corporate finance and treasury department and have just been assigned to the team estimating Disney's WACC. You must estimate this WACC in preparation for a team meeting later today. You quickly realize that the information you need is readily available online.

1. Go to http://finance.yahoo.com. Under the "Investing Tab" and then "Market Overview," you will find the yield to maturity for ten-year Treasury bonds listed as "10 Yr Bond(%)." Collect this number as your risk-free rate.

2. In the box next to the "Get Quotes" button, type Walt Disney's ticker symbol (DIS) and press enter. Once you see the basic information for Disney, find and click "Key Statistics" on the left side of the screen. From the key statistics, collect Disney's market capitalization (its market value of equity), enterprise value (market-value equity + net debt), cash, and beta.

3. To get Disney's cost of debt and the market value of its long-term debt, you will need the price and yield to maturity on the firm's existing long-term bonds. Go to http://cxa.marketwatch.com/finra/BondCenter/Default.aspx. Under "Quick Bond Search," click "Corporate" and type Disney's ticker symbol. A list of Disney's outstanding bond issues will appear. Assume that Disney's policy is to use the expected return on noncallable ten-year obligations as its cost of debt.Find the noncallable bond issue that is as close to 10 years from maturity as possible. (Hint: You will see a column titled "Callable"; make sure the issue you choose has "No" in this column.)Find the yield to maturity for your chosen bond issue (it is in the column titled "Yield"). Hold the mouse over the table of Disney's bonds and right-click. Select "Export to Microsoft Excel." (Note that this option is available in IE, but may not be in other browsers.) An Excel spreadsheet with all of the data in the table will appear.

4. You now have the price for each bond issue, but you need to know the size of the issue. Returning to the Web page, click "Walt Disney Company" in the first row. This brings up a Web page with all of the information about the bond issue. Scroll down until you find "Amount Outstanding" on the right side. Noting that this amount is quoted in thousands of dollars (e.g., $60,000 means $60 million =$60,000,000), record the issue amount in the appropriate row of your spreadsheet. Repeat this step for all of the bond issues.

5. The price for each bond issue in your spreadsheet is reported as a percentage of the bond's par value. For example, 104.50 means that the bond issue is trading at 104.5% of its par value. You can calculate the market value of each bond issue by multiplying the amount outstanding by (Price 100). Do so for each issue and then calculate the total of all the bond issues. This is the market value of Disney's debt.

6. Compute the weights for Disney's equity and debt based on the market value of equity and Disney's market value of debt, computed in Step 5.

7. Calculate Disney's cost of equity capital using the CAPM, the risk-free rate you collected in Step 1, and a market risk premium of 5%.

8. Assuming that Disney has a tax rate of 35%, calculate its after-tax debt cost of capital.

9. Calculate Disney's WACC.

10. Calculate Disney's net debt by subtracting its cash (collected in Step 2) from its debt. Recalculate the weights for the WACC using the market value of equity, net debt, and enterprise value. Recalculate Disney's WACC using the weights based on the net debt. How much does it change?

11. How confident are you of your estimate? Which implicit assumptions did you make during your data collection efforts?

Question 05.

Assume the Finch family of Charlotte, North Carolina, purchased their home in 1966 for $50,000. Since then, comparable homes in their neighborhood have most recently sold for $150,000. The cost to replace the home would be $169,500. It is estimated that the house is one third (1/3) depreciated. The Finch's have a $135,600 (Coverage A) Homeowners policy in force, similar to the policy shown in the Appendix. Answer the following questions as if each question were a separate event. (Assume no deductible)

1) How much will the Finch's collect for a total covered fire loss under coverage A?

2) How much will be collected for a $20,000 partial loss under coverage A?

3) What would be your answer to questions 1 above if the Finch's had only $101,700 of insurance for Coverage A?

4) What would be your answers to question 2 above if the Finch's had only $101,700 of insurance for Coverage A?

Question 07.

work out the following questions.

You would like to invest your savings of $20,000 into a diversified portfolio of stocks. You have already identified two publicly listed companies and have collected the following information. Daisy Plc. has been operating in the pharmaceutical sector for over 30 years and its shares are expected to provide an annual return of 12.00%. The annual standard deviation of these returns is 6.00%. Blue Plc. is a relatively new company operating in the technology sector for the last 7 years. The following information is provided for Blue Plc.: State of the Probability of the state of Returns on Blue Pic. economy economy Poor 30% 5.00% Normal 50% 16.00% Growth 20% 25.00% You plan to invest your savings equally in both stocks and have found the correlation coefficient of their returns to be equal to 0.20. You are required to: a. Calculate the expected rate of return and standard deviation of returns on Blue Plc investment. (10 marks) b. Calculate the expected rate of return and standard deviation of returns on the portfolio of investments in Blue Plc. and Daisy Pic. Explain your findings. (15 marks) C. You expect to receive a return of 13.00% on the two-stock portfolio, Estimate the standard deviation of returns on this portfolio and discuss your findings when compared with the results in part b. (18 marks) (up to 50 words) d. Assume that returns on both stocks are perfectly negatively correlated. Estimate the expected rate of return and standard deviation of returns for the portfolio with equal investment in both stocks. (7 marks) li. Estimate the expected rate of return on the portfolio of these two stocks, when the standard deviation on portfolio returns is equal to zero. Briefly explain the role of diversification. (18 marks) (up to 50 words)- This convertible bond is currently trading at $81.39 a) What is the convertible bond's fair price? Is it mispriced? b) Is there a true arbitrage opportunity here? That is, can you devise a profitable strategy that can't lose money? What is the strategy? What are the cash flows to this strategy? c) Suppose you can lever your position 20 times. That is, suppose for every dollar you get shorting you: - Can use the proceeds to buy assets, which your broker will hold as collateral, - And you must leave an additional $:05 cash in a margin account, also with your broker " This margin account earns interest at the rate r - 2% = 9.11%, i.e., you're "taking a haircut," "rebating" 2% of the interest earned on this account to the broker What is the return and standard deviation to your arbitrage strategy with this leverage?Fmbl'n 4: Suppose you run a convertibles arbitrage hedge fund. You've noticed a potential trading opportunity related to the different securities issued by Eval Corporation. In particular, you think there may be an opportunity associated with ENM's convertible debt. The market conditions you're facing are as follows: I Interest rates are stable [i.e., you can ignore interest rate risk]. and the yield curve is flat at 11.11%. I The current market prices of riskless one and two years zero-coupon bonds [with $100 facevalue} are: 31 = $90 B: = $31 In The stock of ENM is currently trading at $311}, and will either go up or down each of the next two years aocording to the following tree $123.33 $91.33 $73