FIN 415 Fall 2020 Quiz 3 20201213

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University of Michigan *

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415

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Finance

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May 9, 2024

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FIN 415 CORPORATE INVESTMENT DECISIONS QUIZ 3 Instructions You have 240 minutes. There are 10 multiple choice questions. Each question is worth the same. Each question has one correct answer. A correct answer gives you one point; an incorrect answer gives you zero points. You will need to use Excel to complete the quiz. Retain all decimal places in your calculations. If you round inputs then some of your calculations will be incorrect. The exam is open book. You can use any resources at all to complete the quiz, but you cannot collaborate with any other people, classmates or otherwise. Your score will be based on your multiple-choice answers. But you must also submit the spread sheet used in calculations. There can be instances in which an exam question has an error, or is subject to an alternative, but reasonable interpretation. If this happens I will refer to your spread sheet in deciding whether to award a point. When you submit your quiz, make sure you give me the following information. Your letter answer for each question (in the quiz response and in the first work sheet of your spread sheet under “Answer”). Your numerical answer for questions that have a numerical solution (in the quiz response and LINKED to your computations in your spread sheet in the first work sheet under “Computations”). Your computations in Excel. Don’t just give me your final numerical solutions – I want to see the actual computations you performed.
FIN 415 Corporate investment decisions Quiz 3 2 Questions Question 1: Market risk premium In the data file you have the following information. Annual levels of the S&P 1500 total returns index; Government bond yields for bonds with a 10-year maturity at the start of each year, expressed as an effective annual rate; and Annual levels of the seasonally-adjusted consumer price index. Assume that, today, the 10-year government bond yield is 0.92% and a reasonable estimate of inflation is 1.88%, both expressed as an effective annual rate. In class we discussed two ways of estimating the market risk premium based upon historical sharemarket returns and government bond yields. Estimate the market risk premium today, based upon the average of the two approaches we used to estimate the market risk premium from historical data. 1. What is your estimate of the market risk premium? a. 5.7% to 6.0% b. 6.0% to 6.3% c. 6.3% to 6.6% d. 6.6% to 6.9% e. 6.9% to 7.2% f. 7.2% to 7.5% g. 7.5% to 7.8% h. 7.8% to 8.1% i. 8.1% to 8.4% j. 8.4% to 8.7%
FIN 415 Corporate investment decisions Quiz 3 3 Question 2: Cost of equity Your task is to estimate the cost of equity for a company in the health care facilities industry. Your analysis will rely, in part, on the Capital Asset Pricing Model and, in part, on the relationship between leverage and the cost of equity. There are 3 comparable firms in the dataset: Hanger, HCA and Davita. The table below shows the comparable firms’ market capitalization and debt in $ million. The data file has weekly stock returns for these 3 companies and the S&P 1500 index. Assume each comparable firm maintain its same leverage in percentage terms in all historical and future years and that the cost of debt for comparable firms and the firm you will analyze is 4%. Comparable firm Hanger HCA Davita Market capitalization 881 53,318 12,132 Debt 499 33,722 8,108 Your task is to estimate the cost of equity for a health care facilities company assuming a risk-free rate of 2%, market risk premium of 6%, cost of debt of 4% and debt/(debt + equity) of 20%. Assume leverage will remain constant in percentage terms in all forecast years. Do not use median in any computations. 2. What is your estimate of the cost of equity? a. 7.75% to 8.00% b. 8.00% to 8.25% c. 8.25% to 8.50% d. 8.50% to 8.75% e. 8.75% to 9.00% f. 9.00% to 9.25% g. 9.25% to 9.50% h. 9.50% to 9.75% i. 9.75% to 10.00% j. 10.00% to 10.25%
FIN 415 Corporate investment decisions Quiz 3 4 Question 3: Exchange rates You have been asked to perform a valuation of an apparel retailer in the United Kingdom. The business generates cash flows in British Pounds and your valuation will be in U.S. dollars. Today, 1 U.S. dollar is worth 0.7561 British Pounds. The list below shows 1- and 2-year forward currency rates, and the yield to maturity on 5-year government bonds in the U.K. and the U.S., expressed as effective annual rates.. 1-year forward rate: 1 U.S. dollar = 0.7546 British Pounds 2-year forward rate: 1 U.S. dollar = 0.7528 British Pounds 5-year government bond yield U.S. = 0.36% 5-year government bond yield U.K. = -0.12%. The projected free cash flow to the firm, in British Pounds, is £100 in forecast year 1, and you think cash flows will grow at 6% each year for 4 years, and then grow at 4% per year in perpetuity. The weighted average cost of capital, from the perspective of a U.S. investor, is 8%. What is the enterprise value in U.S. dollars? 3. What is the enterprise value in U.S. dollars? a. $3,570 million to $3,600 million b. $3,600 million to $3,630 million c. $3,630 million to $3,660 million d. $3,660 million to $3,690 million e. $3,690 million to $3,720 million f. $3,720 million to $3,750 million g. $3,750 million to $3,780 million h. $3,780 million to $3,810 million i. $3,810 million to $3,840 million j. $3,840 million to $3,870 million
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