Based on the Hamada equation, what would the firm’s beta be if it used no debt, i.e., what is its unlevered beta?

Finance by Geoffrey

Project (20 points)

Note: Write down the steps and results of each step of the calculation process.

 

  1. (4 points)

 

ABC Inc.’s capital structure is 40% debt, 30% preferred, and 30% common equity, and its tax rate is 35%. For financing, (a) ABC sold a non-callable bond several years ago that now has 15 years to maturity with 8% annual coupon, paid semiannually, at a price of $1,055, and a par value of $1,000. (b) ABC sold a perpetual preferred stock for $95.50 per share, with a $7.50 annual dividend and a flotation cost of 3.00% of the price. (c) ABC also has beta = 1.2, risk free rate of return rRF = 6.00%; market risk premium RPM = 7.00%;

 

The question is: What is the company’s WACC?

 

 

  1. (4 points)

 

ABC is considering a project that has the following cash flow and WACC data.

 

  • What is the project’s NPV?
  • What is the project’s IRR
  • What is the project’s MIRR?
  • Should the project be accepted? Why?

 

WACC:  The result of (1) above

 

Year              0        1        2        3        4        5  

Cash flows     -$1,200    $420     $380     $360     $340     $320

 

 

  1. (4 points)

 

ABC is now considering changing the debt ratio and moving it to the new debt/assets ratio as indicated below, and replacing all preferred stocks with debt.  The money raised would be used to repurchase preferred stock at the current price.  It is estimated that the increase in risk resulting from the additional leverage would cause the required rate of return on equity to rise somewhat, as indicated below.  If this plan were carried out,

 

  • By how much would the WACC change, i.e., what is WACCOld – WACCNew (WACC (in question (1) or (2)) – WACC (in question (3))?

New Debt/Assets               45%      Interest rate new = rd       7.0%

New Equity/Assets             55%      New cost of equity = rs     13.0%

 

  • Based on the Hamada equation, what would the firm’s beta be if it used no debt, i.e., what is its unlevered beta?

 

  1. (4 points)

 

ABC is planning its operations for next year, and wants to forecast the firm’s additional funds needed (AFN).  Data for use in the forecast are shown below. Based on the AFN equation, what is the AFN for the coming year?  Dollars are in millions.

 

Last year’s sales = S0               $700   Last year’s accounts payable      $45

Sales growth rate = g                18%   Last year’s notes payable         $55

Last year’s total assets = A*0       $500   Last year’s accruals              $35

Last year’s profit margin = M         5%   Target payout ratio               50%

 

 

  1. (4 points)

 

 

On 4/10/2022, the exchange rates are as follows:

 

1 British Pound = USD $1.30

 

1 Australian dollar = 0.57 British Pound

 

1 Australian dollar = 87.59 Japanese Yen

 

$1 USD = 1.34 Australian dollar

 

$1 USD = 124.46 Japanese Yen

 

 

  • ABC is considering expanding its sales of orange juice overseas. If the product is produced in ABC’s Australian brunch with cost 2.20 Australian dollars, ship to UK, where it can be sold for 1.54 British pound. What is the profit measured by US dollars on the sale?

 

 

 

  • If ABC produces a liter of orange juice in its US headquarters and ship it to Japan for USD $1.45 per unit. If the firm wants a 25% markup on the project, what should be the price of the juice sold in Japan measured by Yen, if using the exchange rate as shown above?

 

 

  • If the shipped orange juice in Japan is actually sold for 215 Yen, by PPP, what is the exchange rate between USD and Yen (Yen/USD $1) implied?