Question 3: Model of Returns

a) Define and explain the arithmetic and geometric mean, and under what circumstances are they used?

b) Define and explain the skewness and kurtosis coefficients, and what are they used for?

c) Define and explain the models of Fama and French (1993), Pastor and Stanbaugh (2003) and the interpretation of a interpretation of a coefficient of your choice using a numerical example.

d) Explain how beta could be adjusted for leverage?

Question 4:

Charles Jones seeks to value Reliant Home Furnishing using a 3-level growth model.

He obtained the following information:

- Current free cash flow (FCFF) = $755 million;

- Outstanding shares = $311 million;

- Equity beta = 1.02; risk-free rate: 4.9%; equity premium = 5.11%;

- Cost of debt 7.1%;

- Marginal tax rate = 34%;

- Capital structure = 23% debt, 77% equity;

- Long-term debt = 1.4 billion;

- Growth rate of FCFF = 8.1% per year for level 1, year 1-4;

7.3% for year 5, 5.9% for year 6, 4.5 for year 7

3.01% for year 8 and beyond.

From the information Jones has accumulated, estimate:

1. The weighted average cost of capital (WACC)

2. The total value of the firm

3. Total equity value

4. The value per share.

5. Give the definition of FCFF by explaining each of the components that make up this value.