Question

You need to estimate the equity cost of capital for XYZ Corp. You have the following data available regarding past returns: E a. What was XYZ's average historical return? b. Compute the market's and XYZ's excess returns for each year. Estimate XYZ's beta. c. Estimate XYZ's historical alpha. d. Suppose the current risk-free rate is 2%, and you expect the market's return to be 10%. Use the CAPM to estimate an expected return for XYZ Corp.'s stock. e. Would you base your estimate of XYZ's equity cost of capital on your answer in part (a) or in part (d)? a. What was XYZ's average historical return? XYZ's average historical return was % (Round to one decimal place.) b. Compute the markets and XYZ's excess returns for each year. The market's excess return for 2011 was%. (Round to the nearest integer.) The market's excess return for 2012 was%(Round to the nearest integer.) XYZ's excess return for 2011 was % (Round to the nearest integer.) Data Table XYZs excess retum for 2012 was % (Round to the nearest Integer) Estimate XYZ's beta (Cick on the icon located on the top-night comer of the data table below in order to copy XYZ's betais (Round to two decimal places.) its contents into a spreadsheet) Year Risk-free Return Market Return c. Estimate XYZ's historical alpha. 7% 11% -42% 43% XYZ Return 2011 2012 4% 1% Click to select your answer(s).

Answer 1

a) Ansa) Xyz's historical Average return xyz's company's 2011 return = Xyz Company's 2012 return Il yo – 43% Xyz's Average historical return = 11-43 % 2 -16% (xyz's Aus historical return = -16% Average A b) Ans. Excess Return = Actual Retwen - Risk-free Return go 6 Actual Return Risk-free Rate Market 2011 2012 7% -42% 4% 10% X YZ Company 2011 2012 11% -434 4% 1 % of Return (7-4)% -42-1% Excess Return = 30% -43% (11-4)% 7% (-43-1) % -44% Betals). 'Change in xyz's Encess Return Change in Market's Excess Return xyz's Encess Return = 7% - (-40%) 7% + 44% Ichange in xyz's Excess Return Change in 2 = 5140

Change in Market's Excess Retwin = 3% - (-43%) - 3% t 43% I change in Market's Excess Return 46% o. Beta (B) 51% 46% Beta (B) 2 to the Result of c) Aus) According Alpha = Intercept (b) (E(R3) - 44) – B(E[Rm) - 17 (7% -44%) 011/3%- 43% 2 2. :- 18.5% - (1.11)X6 2027) - 18.5% +22.20% Alpha historical 3,704 xyz Company. Note: (Rs) (R$) Excess Return) 7% 44% Market (Rm) 3 % :(rf) -43%

d) Aus Return Using the CAPM. to estimated for xyz Corp's stock. We Enow, Expected Retwin = Current Risks + Beta (Market's – Print E [R] free Rate (Rt) (B) Retwen frey Here, (RA) Current Risk free Rate = 2% Market's Retwen = 10% by using the Result of (b) Beta (B) = lill E [R 24 + 1.11 x (10% 2%) 12 2 % loll t X 8% a 20% t 8.88 % E[R] 10.88%

Hence 10.88% for 1 Aus Expected Retwin E (R) XYZ". Corp's stock. • e) Aus Use CAPM is more а (d) reliable than average past retwins, which would imply Negative cost of capital in this case.