Question

Below are five comparable compaies that compete in the Widget industry: Company V, Company W, Company X, Company Y and Company Z. Assume the greater the assets on the balance sheet, the larger the company. Use the financial statement information in the table below to help answer questions 1-5 Debt/Equity YTM Total Asscts Tax Rote Net Incomc Book Vakuc Didends Re Compony V 0.5385 .0000 0.5625 0.4925 4.0000 8.0% 9.0% 6.0% 60% 11.0% 100 1060 1000 970 100 30.0% 35.00% 35.096 30.0% 30.0% 26 53 120 .25 1.35 1.10 1.15 1.40 65 265 640 650 1.5 40 64 15.2% 12.9% 13.4% i 5.096 Company Y Companyz 1.Compared to larger companies in the Widget industry, smaller companies in the Widget industry A. have a higher payout ratio B. have a lower retention ratio C. have a lower effective tax rate D. have a faster long term growth rate E. have more debt as a percentage of the capital structure 2.The CAPM was used to calculate the cost of equity (Re) for each company in the table. Which of thefollowing statements is most likely TRUE A, a 2 year US treasury is yielding 2% and the expected market return is 1 1% B. a 2 year US treasury is yielding 3% and the expected market return is13% C. a 10 year US treasury is yielding 3% and the expected market return is 9% D. a 10 year US treasury is yielding 2% and the expected market return is 10% E. a 10 year US treasury is yielding 3% and the expected market return is 12% 3.Company Alpha is also in the Widget industry. Currently, the company has $720M in total assets on thebalance sheet and no debt. Thus, the yield to maturity (YTM) on existing debt does not exist. The CFO isconsidering adding up $360M of long term debt to the capital structure Using the table of comparablecompanies, the cost of debt for Company Alpha is approximately: B. 8% С. 9% D. 11% E. 12% 4.The company with the lowest weighted average cost of capital is: A. Company V B. Company C. Company X D. Company Y E. Company Z 5.Based on the betas for all companies Evaluate the underlined words in italics. True or False?

Answer 1

1. option C: being larger companies have tax base on higher side I. e. 35% like company W and smaller companies have lower rate i.e. 30%.

2. in the absence of period of companies given in chart computation of Re using CAPM is not feasible.

3. being Company Alpha have assets of Rs. 720/- and debts of Rs. 360/- which gives debt/equity ratio of 0.5 approx. , there it will be categorised to give YTM of 6% . (Similar to Company X).

4. Company Y being lowest in Debt/equity ration* YTM , gives lowest weighted average cost of capital .

5. Beta gives effect on the value of share with corresponding effect of systematic changes internally or through external forces in industry. Higher the beta , higher will be volatility in value of shares. Widget industry is more likely non-cyclical than cyclical because beta's give by companies in the industry are not on higher side. Max beta of Company Z is 1.40 which is non-cyclical effect on value of shares. Thus Widget group is more non-cyclical than cyclical.