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Chapter 7

This document provides information to calculate expected returns and weighted betas for different investments. It gives unlevered and levered betas, risk free rates, and market risk premiums. It then uses this information to calculate expected returns for short term investors, long term investors, and different companies/industries based on their debt to equity ratios and tax rates. Weighted averages are also calculated to determine overall betas and expected returns for a portfolio consisting of different assets.

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Francis Joseph C. Arong
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Download as XLSX, PDF, TXT or read online on Scribd
22 views

Chapter 7

This document provides information to calculate expected returns and weighted betas for different investments. It gives unlevered and levered betas, risk free rates, and market risk premiums. It then uses this information to calculate expected returns for short term investors, long term investors, and different companies/industries based on their debt to equity ratios and tax rates. Weighted averages are also calculated to determine overall betas and expected returns for a portfolio consisting of different assets.

Uploaded by

Francis Joseph C. Arong
Copyright
© © All Rights Reserved
Available Formats
Download as XLSX, PDF, TXT or read online on Scribd
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Quote = 8

Given Data:

Risk Free Rate for Treasury Bill 5.80%


Risk Free Rate for Treasury Bonds 6.40%
Market Risk Premium for Treasury Bill 8.76%
Market Risk Premium for Treasury Bonds 5.50%
Beta 0.95

Expected Return for Short Term Investors = Risk Free Rate + (Beta * Market Risk Premium)
Expected Return for Short Term Investors = 5.80% + (0.95 * 8.76%)
Expected Return for Short Term Investors = 14.12%

Expected Return for Long Term Investors = Risk Free Rate + (Beta * Market Risk Premium)
Expected Return for Long Term Investors = 6.40% + (0.95 * 5.50%)
Expected Return for Long Term Investors = 11.63%
Quote = 8

Given Date:
Beta 0.95
Debt in Billions 1.7
Equity in Billions 1.5
Tax Rate 36%

Unlevered Beta = Levered Beta / (1 + ((1-Tax Rate) * (Debt / Equity)))


Unlevered Beta = 0.95 / (1+((1-36%) * (1.7/1.5)))
Unlevered Beta = 8+

Business risk attributable to total risk: Unlevered Beta / Levered Beta


Business risk attributable to total risk: 0.55 / 0.95
Business risk attributable to total risk: 842%

Financial risk attributable to total risk: 1 - Business Risk


Financial risk attributable to total risk: 1 - 0.58
Financial risk attributable to total risk: -742%
Quote = 8

Given Data:
Beta 1.7
Risk Free Rate of T-Bond 6.40%
Market Risk Premium of T-Bond 5.50%

Expected Return = Risk Free Rate + (Beta * Market Risk Premium)


Expected Return = 6.40% + (1.7 * 5.50%)
Expected Return = 15.75%

Changed Data:
Beta 1.7
Risk Free Rate of T-Bond 7.50%
Market Risk Premium of T-Bond 5.50%

Expected Return = Risk Free Rate + (Beta * Market Risk Premium)


Expected Return = 7.50%% + (1.7 * 5.50%)
Expected Return = 16.85%
Quote = 10

Given Data:
Beta 1.15
Risk Free Rate of T-Bond 11.50%
Market Risk Premium of T-Bond 5.50%

Market Risk Premium of T-Bond - 5.50%


Country Risk Premium (CDS) 1.30%
Total Risk Premium 6.80%

Expected Return = Risk Free Rate + (Beta * Total Risk Premium)


Expected Return = 11.50% + (1.15*6.80%)
Expected Return = 19.32%
Quote: 17

Given Data:
Beta 1.20
Risk Free Rate of T-Bill 3.00%
Market Risk Premium of T-Bond 8.76%

Expected Return = Risk Free Rate + (Beta * Market Risk Premium)


Expected Return = 3% + (1.20 * 8.76%)
Expected Return = 13.51%

Stock Price now 50


Multiply by Expected Return Percentage on Stocks 13.51%
Expected Return on Stocks 6.76
Add: Stock Price Now 50
Expected Price one year from today, cum-dividends 56.76
Less: Expected Dividends to be Paid 2.50
Expected Price one year from today, ex-dividends 54.26

Given Data:
Beta 1.20
Risk Free Rate of T-Bill 5.00%
Market Risk Premium of T-Bond 8.76%

Expected Return = Risk Free Rate + (Beta * Market Risk Premium)


Expected Return = 5% + (1.20 * 8.76%)
Expected Return = 15.51%

Decrease in Stock Price -4


Add: Dividends received Last year 2
Total Return (Earnings/-Loss) -2
Divided by Base Price ($50 + $4) 54
Actual Return -3.70%

Given Date:
Beta (Current) 1.2
Debt in Billions 50
Equity in Billions 100
Tax Rate 40%

Unlevered Beta = Levered Beta / (1 + ((1-Tax Rate) * (Debt / Equity)))


Unlevered Beta = 1.20 / (1+((1-40%) * (50/100)))
Unlevered Beta = 0.92

Changed Data
Unlevered Data 0.92
Debt in Billions 0
Equity in Billions 150
Tax Rate 40%

Levered Beta = Unlevered Beta * (1 + ((1-Tax Rate) * (Debt / Equity)))


Levered Beta = 0.92 * (1+((1-40%) * (0/150)))
Levered Beta = 0.92
t / Equity)))

ebt / Equity)))
Quote = 15

Levered Beta = Unlevered Beta * (1 + ((1-Tax Rate) * (Debt / Equity)))

Given Data Unlevered Beta


Mainframes 1.10
Personal Computers 1.50
Software 2.00
Printers 1.00

Levered Beta (Mainframes) = Unlevered Beta * (1 + ((1-Tax Rate) * (Debt / Equity)))


Levered Beta (Mainframes) = 1.10 * (1+((1-40%) * (1/2)))
Levered Beta (Mainframes) = 1.43

Levered Beta (Personal Computers) = Unlevered Beta * (1 + ((1-Tax Rate) * (Debt / Equity)))
Levered Beta (Personal Computers) = 1.50 * (1+((1-40%) * (1/2)))
Levered Beta (Personal Computers) = 1.95

Levered Beta (Software) = Unlevered Beta * (1 + ((1-Tax Rate) * (Debt / Equity)))


Levered Beta (Software) = 2.00 * (1+((1-40%) * (1/1)))
Levered Beta (Software) = 3.20

Levered Beta (Printers) = Unlevered Beta * (1 + ((1-Tax Rate) * (Debt / Equity)))


Levered Beta (Printers) = 1.00 * (1+((1-40%) * (1/3)))
Levered Beta (Printers) = 1.20

Levered Beta * Ratio of Equity to Total Equity =


Mainframes 1.43 * 2/8 =
Personal Computers 1.95 * 2/8 =
Software 3.20 * 1/8 =
Printers 1.20 * 3/8 =
Total Beta as a Company

Given Data:
Beta 1.695
Risk Free Rate of T-Bond 7.50%
Market Risk Premium of T-Bond 5.50%

Cost of Equity as a Company = Risk Free Rate + Beta (Market Premium for T-Bond)
Cost of Equity as a Company = 7.5% + (1.695*5.5%)
Cost of Equity as a Company = 16.8225%

Risk Free Rate + (Levered Beta * Market Risk Pre=


Mainframes 7.50% + 1.43*5.5% =
Personal Computers 7.50% + 1.95*5.5% =
Software 7.50% + 3.20*5.5% =
Printers 7.50% + 1.20*5.5% =

Given Data Unlevered Beta


Personal Computers 1.50
Software 2.00
Printers 1.00
Levered Beta (Personal Computers) = Unlevered Beta * (1 + ((1-Tax Rate) * (Debt / Equity)))
Levered Beta (Personal Computers) = 1.50 * (1+((1-40%) * (1/2)))
Levered Beta (Personal Computers) = 1.95

Levered Beta (Software) = Unlevered Beta * (1 + ((1-Tax Rate) * (Debt / Equity)))


Levered Beta (Software) = 2.00 * (1+((1-40%) * (1/1)))
Levered Beta (Software) = 3.20

Levered Beta (Printers) = Unlevered Beta * (1 + ((1-Tax Rate) * (Debt / Equity)))


Levered Beta (Printers) = 1.00 * (1+((1-40%) * (1/3)))
Levered Beta (Printers) = 1.20

Levered Beta * Ratio of Equity to Total Equity =


Personal Computers 1.95 * 2/6 =
Software 3.20 * 1/6 =
Printers 1.20 * 3/6 =
Total Beta as a Company
Weighted Beta
0.358
0.4875
0.400
0.450
1.695

Weighted Beta
15.37%
18.23%
25.10%
14.10%
Weighted Beta
0.65
0.533
0.600
1.783
Quote = 15

Levered Beta = Unlevered Beta * (1 + ((1-Tax Rate) * (Debt / Equity)))

Given Data Unlevered Beta


Mainframes 1.10
Personal Computers 1.50
Software 2.00
Printers 1.00

Unlevered Beta * Ratio of Equity to Total Equity =


Mainframes 1.10 * 2/8 =
Personal Computers 1.50 * 2/8 =
Software 2.00 * 1/8 =
Printers 1.00 * 3/8 =
Weighted Company Unlevered Beta

Levered Beta of Company = Unlevered Beta * (1+((1-Tax Rate)*(Debt/Total Equity)


Levered Beta of Company = 1.2750 * (1+((1-40%)*(1/8)))
Levered Beta of Company = 1.371

Given Data:
Beta 1.371
Risk Free Rate of T-Bond 7.50%
Market Risk Premium of T-Bond 5.50%

Cost of Equity as a Company = Risk Free Rate + Beta (Market Premium for T-Bond)
Cost of Equity as a Company = 7.5% + (1.695*5.5%)
Cost of Equity as a Company = 15.04%

Risk Free Rate + (Levered Beta * Market Risk Pre=


Mainframes 7.50% + 1.10*5.5% =
Personal Computers 7.50% + 1.50*5.5% =
Software 7.50% + 2.00*5.5% =
Printers 7.50% + 1.10*5.5% =

Given Data Unlevered Beta


Personal Computers 1.50
Software 2.00
Printers 1.00

Unlevered Beta * Ratio of Equity to Total Equity =


Personal Computers 1.50 * 2/6 =
Software 2.00 * 1/6 =
Printers 1.00 * 3/6 =
Weighted Company Unlevered Beta

Levered Beta of Company = Unlevered Beta * (1+((1-Tax Rate)*(Debt/Total Equity)


Levered Beta of Company = 1.3333 * (1+((1-40%)*(1/6)))
Levered Beta of Company = 1.467
Weighted Unlevered Beta
0.2750
0.3750
0.2500
0.3750
1.2750

Weighted Beta
13.55%
15.75%
18.50%
13.00%

Weighted Unlevered Beta


0.5000
0.3333
0.5000
1.3333
Quote: 8

Change in Operating Income / Change in Revenue = Degree of Operating Leverage


Pharma Corp 25.00% / 27.00% = 0.93
Syner Corp 32.00% / 25.00% = 1.28
BioMed 36.00% / 23.00% = 1.57
Safemed 40.00% / 21.00% = 1.90
Quote: 10

Unlevered Beta = Levered Beta / (1 + ((1-Tax Rate) * (Debt / Equity)))


Unlevered Beta = 1.20 / (1+((1-40%) * (20/180)))
Unlevered Beta = 1.1250

Unlevered Beta * Ratio of Equity to Total Equity = Weighted Unlevered Beta


Sold Part of the Division 0.6 * 20/180 = 0.0666666666666667

Unlevered Beta of Firm = (Unlevered Beta of Division 1 * (Division 1 Equity/Total Equity)) + (Unlevered Beta of Division 2 * (Di

Unlevered Beta of Firm = (Unlevered Beta of Division Sold * (Division Sold Equity/Total Equity)) + (Unlevered Beta of Division R

Unlevered Beta of Firm = (0.60 * (20/180)) + (1.11627907 * (160/180))

Beta = Unlevered Beta * (1 + ((1-Tax Rate) * (Debt / Equity)))


Beta = 1.180814 * (1+((1-40%) * (40/120)))
Beta = 1.42875
0.0666667 + ((160/180)*x) = 1.162791
0.888889x = 1.162791 - 0.066667
0.888889x = 1.058333
x= 1.190625
0.8888889

evered Beta of Division 2 * (Division 2 Equity/Total Equity))

+ (Unlevered Beta of Division Restructured * (Division Restructured Equity/Total Equity))


Quote: 7

Given Date:
Beta 1.61
Debt in Billions 10
Equity in Billions 10
Tax Rate 40%

Unlevered Beta = Levered Beta / (1 + ((1-Tax Rate) * (Debt / Equity)))


Unlevered Beta = 1.61 / (1+((1-40%) * (10/10)))
Unlevered Beta = 1.01

Given Date (Debt to Equity Ratio is reduced by 10%):


Unlevered Beta 1.01
Debt in Billions 9
Equity in Billions 10
Tax Rate 40%

Levered Beta = Unlevered Beta * (1 + ((1-Tax Rate) * (Debt / Equity)))


Levered Beta = 1.01 * (1+((1-40%) * (1/1)))
Levered Beta = 1.55

Given Date (Debt to Equity Ratio is reduced by another 10%):


Unlevered Beta 1.01
Debt in Billions 8
Equity in Billions 10
Tax Rate 40%

Levered Beta = Unlevered Beta * (1 + ((1-Tax Rate) * (Debt / Equity)))


Levered Beta = 1.01 * (1+((1-40%) * (1/1)))
Levered Beta = 1.49
t / Equity)))

ebt / Equity)))

ebt / Equity)))
Quote: 8

Given Date:
Beta 1.05
Debt in Billions 13
Equity in Billions 17.75
Cash 8
Tax Rate 36%

Unlevered Beta = Levered Beta / (1 + ((1-Tax Rate) * (Debt / Equity)))


Unlevered Beta = 1.05 / (1+((1-36%) * (5/17.75)))
Unlevered Beta = 0.89

Given Date (Debt to Equity Ratio is reduced by another 10%):


Unlevered Beta 0.89
Cash 8
Cash Paid to Dividends 5
Debt in Billions 13
Equity in Billions 17.75
Tax Rate 36%

Levered Beta = Unlevered Beta * (1 + ((1-Tax Rate) * (Debt / Equity)))


Levered Beta = 0.89* (1+((1-36%) * (10/12.75)))
Levered Beta = 1.34
te) * (Debt / Equity)))

Rate) * (Debt / Equity)))


Quote: 8

Unlevered Beta (Balck and Deckers) = Beta / (1+((1-Tax Rate)*(Debt/Total Equity)))


Unlevered Beta (Balck and Deckers) = 1.40 / (1+((1-40%)*(2500/3000)))
Unlevered Beta (Balck and Deckers) = 0.933333

Unlevered Beta (Fedder Corps) = Beta / (1+((1-Tax Rate)*(Debt/Total Equity)))


Unlevered Beta (Fedder Corps) = 1.20 / (1+((1-40%)*(5/200)))
Unlevered Beta (Fedder Corps) = 1.182266

Unlevered Beta (Maytag Corps) = Beta / (1+((1-Tax Rate)*(Debt/Total Equity)))


Unlevered Beta (Maytag Corps) = 1.20 / (1+((1-40%)*(540/2250)))
Unlevered Beta (Maytag Corps) = 1.048951

Unlevered Beta (National Prestos) = Beta / (1+((1-Tax Rate)*(Debt/Total Equity)))


Unlevered Beta (National Prestos) = 0.70 / (1+((1-40%)*(8/300)))
Unlevered Beta (National Prestos) = 0.688976

Unlevered Beta (Whirlpools) = Beta / (1+((1-Tax Rate)*(Debt/Total Equity)


Unlevered Beta (Whirlpools) = 1.50/ (1+((1-40%)*(2900/4000)))
Unlevered Beta (Whirlpools) = 1.045296

Unlevered Beta (Balck and Deckers) = 0.933333


Unlevered Beta (Fedder Corps) = 1.182266
Unlevered Beta (Maytag Corps) = 1.048951
Unlevered Beta (National Prestos) = 0.688976
Unlevered Beta (Whirlpools) = 1.045296
Total 4.898823
Divided by 5
Average Unlevered Beta for Public Firms 0.979765

Beta of Private Firm = Unlevered Beta * (1+((1-Tax Rate)*(Debt/Total Equity)))


Beta of Private Firm = 0.979765 * (1+((1-40%)*(25%)))
Beta of Private Firm = 1.1267

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