1. (Cost of Capital) Suppose that a couple years ago, Yahoo! apart from its core business held a large stake in Alibaba Group. At that time, Yahoo!'s market capitalization was $7 billion, its core business was worth $5 billion with beta of 0.9, and the stake in Alibaba Group was worth $8 billion with beta of 1.5. Yahoo!'s equity cost of capital is 14.5% and the yield to maturity on its outstanding debt was 5.7%. Yahoo!'s marginal tax rate was 20%. The risk free rate was 3% and the market risk premium was 5%. (a) Compute Yahoo!'s asset beta. If Yahoo!'s expected losses in default are 60 cents on a dollar, compute the annual probability of default for Yahoo! (b) Compute Yahoo!'s WACC. Suppose Yahoo! wants to invest in the expansion of its financial services business, which is similar in terms of the market risk to its core business. The current investment are $3.5 million and the increase in EBIT is $300,000 from the next year on. Find the net present value of this new project. Which discount rate should Yahoo! use to discount cash flows from this project? (c) Suppose that Yahoo! did not undertake the new investment, but instead sold its stake in Alibaba and used cash proceeds to pay off its debt and invested the rest into short-term government bonds, which are essentially risk-free. Compute Yahoo!'s equity cost of capital after this deal. 1. (Cost of Capital) Suppose that a couple years ago, Yahoo! apart from its core business held a large stake in Alibaba Group. At that time, Yahoo!'s market capitalization was $7 billion, its core business was worth $5 billion with beta of 0.9, and the stake in Alibaba Group was worth $8 billion with beta of 1.5. Yahoo!'s equity cost of capital is 14.5% and the yield to maturity on its outstanding debt was 5.7%. Yahoo!'s marginal tax rate was 20%. The risk free rate was 3% and the market risk premium was 5%. (a) Compute Yahoo!'s asset beta. If Yahoo!'s expected losses in default are 60 cents on a dollar, compute the annual probability of default for Yahoo! (b) Compute Yahoo!'s WACC. Suppose Yahoo! wants to invest in the expansion of its financial services business, which is similar in terms of the market risk to its core business. The current investment are $3.5 million and the increase in EBIT is $300,000 from the next year on. Find the net present value of this new project. Which discount rate should Yahoo! use to discount cash flows from this project? (c) Suppose that Yahoo! did not undertake the new investment, but instead sold its stake in Alibaba and used cash proceeds to pay off its debt and invested the rest into short-term government bonds, which are essentially risk-free. Compute Yahoo!'s equity cost of capital after this deal
