Question

ow are five comparable companies that compete in the Widget industry: Compony company. Use the financial statement information in the table below to help answer quest ompany X, Company Y, and Company Z. Assume the greater the assets on the balance sheet, the larger the Debt/Equity 0.5385 3.0000 0.5625 0.4925 YTM Total Assets Tax Rate Net Income 80% 9.0% 6.0% 6.0% 30.0% 35.0% 1060 1000 650 30.0% 100 1. Compared to larger companies in the Widget industry, smaller companies in 1 he Widget indust A. have a lower payout ratic B. have a higher retention ratio C. have a lower effective tax rate D. have a faster long term growth rate E. have more debt as a percen tage of the capital structure 2. The CAPM was used to calculate the cost of equity (Re) for each company in the table. Which of the following statements is most likely TRUE r US treasury is yielding 2% and the expected market return is y is yielding 3% and the expected market return is return i 1 1% eturn is 9% expected market return is 12 A. a 2 yea B. a 2 year US treasur 10 year US treasury is yielding 3% and the expected market r US treasury is yielding 2% and the expected market D. a 10 yea E. a 10 year US treasury is yielding 3% and the nt Model, the cost of equity for Company x has 2000 shares ou Company X is closest to: 3. tstanding. Using the Dividend Discou A. 8.25% B. 10.50% C. 12.50% D. 14.50% E. 14.75% 720M in total assets on 4. Company Alpha is also in the Widget industry. Currently, the company has $ sheet and n o debt. Thus, the yield to maturity (YTM) on existing debt does not exi term debt to the capital structure. Using the table of comparab considering adding up $ companies, the cost of debt for Company Alpha is approximately: A. 6% 8% C.9% D. E. 1296 5. The company with the lowest weighted average cost of capital is: A. Company B. Company W C. Company X D. Company Y E. Company Z 6. Based on the betas for all companies, the Widget the underlined words in italics. True or False? A. True B. False

Answer 1

1. Compared to larger companies in the widget industry, smaller companies in the widget inustry

Answer : have a higher long term growth rate (Option D)

Reason: If we see the return on equity (re) of smaller companies V,W and Z, it is higher than the Re of bigger companies X and Y. This is result in higher long term growth rate for smaller companies.

2. Regarding CAPM which one is TRUE

Answer : a 10 year US treasury is yielding 3% and the expected maket return is 12% (Option E)

If we plug these value as per the CAPM for Company V, Rf + beta*(Rm-Rf), 3% +1.25*(12-3) = 14.25% which is the Re for V

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