You decided to use the Fama-French 3-factor model to compute the cost of equity for Pear...
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You decided to use the Fama-French 3-factor model to compute the cost of equity for Pear Corporation. As a first step in your analysis, you download historical data on the returns and estimate the following time-series regression: (rit rft) = a + BM[rM.T - rft] + BSMB [rSmall,t "Big,t] + BHML[r High B/M,t Low B/M,t] + t Your estimates for BM, BSMB and BHML for Pear Corporation were 0.95, 0.43 and 0.25, respectively. The debt-to-value ratio of the company over the estimation period of your regression is 0.20. The Fama-French 3-factor model is given by: E(r) = r + BME[rRMRF] +BSMBE[r SMB] + PHMLE[THML] You also decide to make the following additional assumptions: (i) Risk-free rate given by previous table (U.S. Treasuries). (ii) Market minus Risk-free Risk-premium = E[RRMRF]=5.00%; Small-minus-Big Risk-premium = E[RSMB]=4.50%; High B/M-minus-Low B/M Risk Premium = E[RHML] =3.60% (These are the expected return on each of the 3 risk factors, where the latter are represented by 3 zero-cost long-short portfolios). (iii) Company's debt beta = 0 (for all betas; meaning the debt is not sensitive to any of those risk factors). (iv) Target debt-to-value ratio for the company in the future (as previously described): 0.40. (v) Tax rate= 40%. 2. Based on this approach, what is the cost of equity and after-tax WACC for the company at the target debt-to-value ratio? (Hint: un-lever and re-lever each of the single equity betas, then use the three re-levered equity betas to calculate firm's cost of equity based on the Fama-French 3-factor model. Then simply calculate the after-tax WACC). You decided to use the Fama-French 3-factor model to compute the cost of equity for Pear Corporation. As a first step in your analysis, you download historical data on the returns and estimate the following time-series regression: (rit rft) = a + BM[rM.T - rft] + BSMB [rSmall,t "Big,t] + BHML[r High B/M,t Low B/M,t] + t Your estimates for BM, BSMB and BHML for Pear Corporation were 0.95, 0.43 and 0.25, respectively. The debt-to-value ratio of the company over the estimation period of your regression is 0.20. The Fama-French 3-factor model is given by: E(r) = r + BME[rRMRF] +BSMBE[r SMB] + PHMLE[THML] You also decide to make the following additional assumptions: (i) Risk-free rate given by previous table (U.S. Treasuries). (ii) Market minus Risk-free Risk-premium = E[RRMRF]=5.00%; Small-minus-Big Risk-premium = E[RSMB]=4.50%; High B/M-minus-Low B/M Risk Premium = E[RHML] =3.60% (These are the expected return on each of the 3 risk factors, where the latter are represented by 3 zero-cost long-short portfolios). (iii) Company's debt beta = 0 (for all betas; meaning the debt is not sensitive to any of those risk factors). (iv) Target debt-to-value ratio for the company in the future (as previously described): 0.40. (v) Tax rate= 40%. 2. Based on this approach, what is the cost of equity and after-tax WACC for the company at the target debt-to-value ratio? (Hint: un-lever and re-lever each of the single equity betas, then use the three re-levered equity betas to calculate firm's cost of equity based on the Fama-French 3-factor model. Then simply calculate the after-tax WACC).
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Answer rating: 100% (QA)
To calculate the cost of equity and aftertax Weighted Average Cost of Capital WACC for Pear Corporation using the FamaFrench 3factor model we need to ... View the full answer
Related Book For
Quantitative Investment Analysis
ISBN: 978-1119104223
3rd edition
Authors: Richard A. DeFusco, Dennis W. McLeavey, Jerald E. Pinto, David E. Runkle
Posted Date:
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