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Finance problems regarding the CAPM formula and WACC formula?

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Finance problems regarding the CAPM formula and WACC formula?

Postby bramm » Wed Dec 21, 2011 12:40 am

I have trouble solving these 4 problems in my Finance Homework, I tried multiple times but I still could not figure out the right answer.

1. A company is 40% financed by risk-free debt. The interest rate is 10%, the expected market risk premium is 8%, and the beta of the company's common stock is .5.

Requirement 1:
What is the company cost of capital?

I used the CAPM formula on this on, 10%*.4+.5(8%+10%*.4+10%*.4), got 12%, wrong, I tried putting numbers in the answer box, 10%,8%,6% all wrong.

Requirement 2:
Assume the company pays tax at a 35% rate. What is the after-tax WACC?

I could not figure out what is the equity and debt ratio on this one...

2. Nero Violins has the following capital structure:

Security Beta Total Market Value
($ millions)
Debt 0 $ 100
Preferred stock .20 40
Common stock 1.20 299

What is the firm's asset beta? (Hint: What is the beta of a portfolio of all the firm's securities?) (Round your answer to 2 decimal places.)

Assume that the CAPM is correct and riskfree interest rate of 5% and a market risk premium of 6%. What discount rate should Nero set for investments that expand the scale of its operations without changing its asset beta? (Round your answer to 2 decimal places. Omit the "%" sign in your response.)

This problem I am completely stuck...

3. Binomial Tree Farm's financing includes $5 million of bank loans. Its common equity is shown in Binomial's Annual Report at $6.67 million. It has 500,000 shares of common stock outstanding, which trade on the Wichita Stock Exchange at $18 per share.

Calculate debt and equity ratio

Debt Ratio = 5/(5+6.67+9) = 24% wrong.... ($18*500000 = 9000000)
Equity Ratio = 6.67+9/5+6.67+9 = 27% wrong...

I'm stuck

4. An oil company is drilling a series of new wells on the perimeter of a producing oil field. About 20% of the new wells will be dry holes. Even if a new well strikes oil, there is still uncertainty about the amount of oil produced: 40% of new wells that strike oil produce only 1,000 barrels a day; 60% produce 5,000 barrels per day.

Forecast the annual cash revenues from a new perimeter well. Use a future oil price of $50 per barrel. (Enter your answer in dollars not in millions. Omit the "$" sign in your response.)

This one I have no idea...

Please help!! :(
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