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ALL WORK MUST BE DONE IN EXCELChapter 11: Answer Questions 11.1 , 11.3 on page 379 and problem 17 on page 382 of your textbook. Chapter 13 Leverage and Capital Structure: Critical thinking: Questions 13.5,13.7,13.10 on pages 449/450 Exercises: Problem One: 1 on page 450 of your textbookCHAPTER 11
Risk and Return
CHAPTER REVIEW AND SELF-TEST PROBLEMS
11.1 Expected Return and Standard Deviation. This problem will give you
are two assets and three states of the economy:
some practice calculating measures of prospective portfolio performance. There
(1)
State of
(2)
Probability
of State
of Economy
(3)
Stock A
Rate of Return
if State Occurs
(4)
Stock B
Rate of Return
if State Occurs
Economy
Recession
Normal
Boom
.10
.60
.30
-.20
.10
.70
.30
.20
.50
What are the expected returns and standard deviations for these two stocks? (See
Problem 7.)
11.2 Portfolio Risk and Return. In the previous problem, suppose you have
\$20,000 total. If you put \$6,000 in Stock A and the remainder in Stock B, what will
be the expected return and standard deviation on your portfolio? (See Problem 10.)
11.3 Risk and Return. Suppose you observe the following situation:
Expected Return
Security
Beta
Cooley, Inc.
Moyer Co.
1.6
1.2
19%
16
If the risk-free rate is 8 percent, are these securities correctly priced? What would
the risk-free rate have to be if they are correctly priced? (See Problems 19, 20.)
11.4 CAPM. Suppose the risk-free rate is 8 percent. The expected return on the
market is 14 percent. If a particular stock has a beta of .60, what is its expected
return based on the CAPM? If another stock has an expected return of 20 percent,
what must its beta be? (See Problem 13.)
11.1
Answers to Chapter Review and Self-Test Problems
The expected returns are just the possible returns multiplied by the associated
probabilities:
E(R) = .10 X -.20+.60 X .10+.30 X.70 = 25%
E(R) = .10 .30 +.60 X .20 + .30 .50 = 30%
The variances are given by the sums of the squared deviations from the expected
returns multiplied by their probabilities:
o = .10 X (-.20 -25)2 + .60 X (.10 – 25)2 +.30 X (.70 – .25)2
= .10 X -.452 + .60 X -.152 + .30 X .452
= 19.X.2025 + .60 X .0225 +.30 X.2025
LO4
LO4
204
stock be?
15. Using CAPM. A stock has an expected return of 10.9 percent, its beta is.85, and
the risk-free rate is 4.6 percent. What must the expected return on the market be?
16. Using CAPM. A stock has an expected return of 12.5 percent and a beta of
1.15, and the expected return on the market is 11.5 percent. What must the risk-free
rate be?
17. Using CAPM. A stock has a beta of 1.15 and an expected return of 10.4 percent.
A risk-free asset currently earns 3.8 percent.
a. What is the expected return on a portfolio that is equally invested in the two
assets?
b. If a portfolio of the two assets has a beta of .7, what are the portfolio weights?
If a portfolio of the two assets has an expected return of 9 percent, what is its
beta?
C.
04
d. If a portfolio of the two assets has a beta of 2.3, what are the portfolio weights?
How do you interpret the weights for the two assets in this case? Explain.
18. Using the SML. Asset W has an expected return of 12.1 percent and a beta of
1.18. If the risk-free rate is 3.7 percent, complete the following table for portfolios of
Asset W and a risk-free asset. Illustrate the relationship between portfolio expected
return and portfolio beta by plotting the expected returns against the betas. What is
the slope of the line that results?
Percentage of Portfolio
in Asset W
Portfolio
Expected Return
Portfolio
Beta
0%
25
Long-Term Financing
13.3 Optimal Capital Structure. Is there an easily identifiable debt-equity ratio
PART 7
that will maximize the value of a firm? Why or why not?
13.4 Observed Capital Structures. Refer to the observed capital structures given
in Table 13.5 of the text. What do you notice about the types of industries with
respect to their average debt-equity ratios? Are certain types of industries more
likely to be highly leveraged than others? What are some possible reasons for this
observed segmentation? Do the operating results and tax history of the firms play
a role? How about their future earnings prospects? Explain.
13.5 Financial Leverage. Why is the use of debt financing referred to as using
financial “leverage”?
13.7 Bankruptcy and Corporate Ethics. As mentioned in the text, some firms
– have filed for bankruptcy because of actual or likely litigation-related losses. Is
this a proper use of the bankruptcy process?
13.8 Bankruptcy and Corporate Ethics. Firms sometimes use the threat of a
bankruptcy filing to force creditors to renegotiate terms. Critics argue that in such
an ethical tactic?
cases, the firm is using bankruptcy laws “as a sword rather than a shield.” Is this
13.9 Bankruptcy and Corporate Ethics. As mentioned in the text, Continental
Airlines filed for bankruptcy, at least in part, as a means of reducing labor costs.
Whether this move was ethical, or proper, was hotly debated. Give both sides of
the argument.
13.10 Capital Structure Goal. What is the basic goal of financial management with
regard to capital structure?
AND PROBLEMS connect Select problems are available in McGraw-Hill
|FINANCE
1. EBIT and Leverage. Kaelea, Inc., has no debt outstanding and a total
market value of \$125,000. Earnings before interest and taxes, EBIT, are
projected to be \$10,400 if economic conditions are normal. If there is strong
expansion in the economy, then EBIT will be 20 percent higher. If there is
a recession, then EBIT will be 35 percent lower. Kaelea is considering a
\$42,000 debt issue with a 6 percent interest rate. The proceeds will be used
to repurchase shares of stock. There are currently 6,250 shares outstanding:
Ignore taxes for this problem.
a.
Calculate parn
LO 1
Whether this move was ethical, O
the argument.
13.10 Capital Structure Goal. What is the basic goal of financial management with
regard to capital structure?
Select problems are available in McGraw-Hill
Connect. Please see the packaging options
|FINANCE
LO 1
-13)
1. EBIT and Leverage. Kaelea, Inc., has no debt outstanding and a total
market value of \$125,000. Earnings before interest and taxes, EBIT, are
projected to be \$10,400 if economic conditions are normal. If there is strong
expansion in the economy, then EBIT will be 20 percent higher. If there is
a recession, then EBIT will be 35 percent lower. Kaelea is considering a
\$42,000 debt issue with a 6 percent interest rate. The proceeds will be used
to repurchase shares of stock. There are currently 6,250 shares outstanding.
Ignore taxes for this problem.
a. Calculate earnings per share, EPS, under each of the three economic scenarios
before any debt is issued. Also, calculate the percentage changes in EPS when
the economy expands or enters a recession.
b. Repeat part (a) assuming that Kaelea goes through with recapitalization. What
do you observe?
2. EBIT, Taxes, and Leverage. Repeat parts (a) and (b) in Problem 1 assuming
Kaelea has a tax rate of 35 percent.
3. ROE and Leverage. Suppose the company in Problem 1 has a market-to-book
ratio of 1.0.
Calculate return on equity, ROE, under each of the three economic scenarios
LO 2
LO 2
а. .

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