Posted: April 15th, 2016

Calculate the company’s cost of equity capital using the CAPM mode??

Listed below is financial information for Bulls, Inc.
Total Assets $38,673
Book value of debt $11,258
Average borrowing cost 10%
Common Equity:
Book Value $21,489
Market Value $42,698
Marginal Income Tax Rate 37%
Market Equity Beta 1.1
Risk-free Rate 4.5%
Market Premium 6.5%

1.
a. Given Bulls, Inc. market beta, how did the company’s stock returns compare to the market return?

b. Calculate the company’s cost of equity capital using the CAPM model.

c. Calculate weighted-average cost of capital.

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2.
Is it a good idea to rate the performance of managers based solely on the DCF model?

Explain why and give an example to support your answer.

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3.
The following information (in millions) pertains to a small publicly-traded company.

Cumulative present value of horizon period ROPI $16,000
Present value of terminal period ROPI 44,000
Net operating assets, beginning of year 18,000
Net nonoperating obligations 6,000
Number of shares outstanding, in millions 625

Use ROPI model to value the equity of the company.

The company’s stock is currently trading at $100 per share. How does your valuation estimate compare with this closing price?

What do you believe are some reasons for the difference?

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4.
You have recently taken a position as CFO of High Tech Corporation, a manufacturer of consumer electronics. The industry is widely regarded as one of the more stable across the economic spectrum and offers good long-term growth prospects. In addition to High Tech Corp., there are several other well-capitalized competitors, and each company commands roughly identical market shares. Each competitor has highly efficient manufacturing processes and operates at virtually identical margins. In your new position as CFO, your incentive compensation plan is primarily driven by ROPI. High Tech Corp. has historically been ROPI neutral while its peers in have been ROPI positive.
High Tech Corp. Industry Peers
Net operating profit margin (NOPM) 12.0% 12.0%
Working Capital as % of NOA 20.0% 15.0%
Debt to market value of equity (%) 0.0% 34.0%
Cost of Debt 4.0% 4.0%
Cost of Equity 9.0% 10.0%
WACC 9.0% 8.0%

Using the provided information, suggest and explain two specific and IMMEDIATE actions for High Tech Corp. to achieve positive ROPI.

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