umuc-fin620-homework-4

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Problem 16-29 Stockholder Risk

Suppose a firm’s business operations mirror movements in the economy as a whole very closely—that is, the firm’s asset beta is 1. Find the equity beta for this firm for debt–equity ratios of 0, 1.5, 5.5, and 15. (Do not round intermediate calculations and round your final answer to 1 decimal place. (e.g., 32.1))

Debt-Equity Ratio

Equity Beta

0

1.5

5.5

15


Problem 16-20 MM Proposition I without Taxes

Alpha Corporation and Beta Corporation are identical in every way except their capital structures. Alpha Corporation, an all equity firm, has 11,000 shares of stock outstanding, currently worth $30 per share. Beta Corporation uses leverage in its capital structure. The market value of Beta’s debt is $61,000, and its cost of debt is 9 percent. Each firm is expected to have earnings before interest of $71,000 in perpetuity. Neither firm pays taxes. Assume that every investor can borrow at 9 percent per year.

a.

What is the value of Alpha Corporation? (Do not round intermediate calculations.)

Value of Alpha

$

b.

What is the value of Beta Corporation? (Do not round intermediate calculations.)

Value of Beta

$

c.

What is the market value of Beta Corporation’s equity? (Do not round intermediate calculations.)

Market value of Beta’s equity

$

d.

How much will it cost to purchase 20 percent of each firm’s equity? (Do not round intermediate calculations.)

Amount to invest

Alpha

$

Beta

$


e.

Assuming each firm meets its earnings estimates, what will be the dollar return to each position in part (d) over the next year? (Do not round intermediate calculations.)

Dollar return on investment

Alpha

$

Beta

$


References

Worksheet

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