1. In mid-2012, Ralston Purina had AA-rated, 10-year bonds outstanding with a yield to maturity of 1.96%. a. What is the highest expected return these bonds could have? b. At the time, similar maturity Treasuries had a yield of 0.96%. Could these bonds actually have an expected return equal to your answer in part (a)? c. If you believe Ralston Purina's bonds have 1.5 % chance of default per year, and that expected loss rate in the event of default is 32 %, what is your estimate of the expected return for these bonds?

2. In mid-2009, Rite Aid had CCC-rated, 13-year bonds outstanding with a yield to maturity of 17.3%. At the time, similar maturity Treasuries had a yield of 3%. Suppose the market risk premium is 5% and you believe Rite Aid's bonds have a beta of 0.36. The expected loss rate of these bonds in the event of default is 53%. a. What annual probability of default would be consistent with the yield to maturity of these bonds in mid-2009? b. In mid-2012, Rite-Aid's bonds had a yield of 8.6%, while similar maturity Treasuries had a yield of 1%. What probability of default would you estimate now? 3. Your firm is planning to invest in an automated packaging plant. Harburtin Industries is an all-equity firm that specializes in this business. Suppose Harburtin's equity beta is 0.85, the risk-free rate is 4.0%, and the market risk premium is 5.0%. If your firm's project is all-equity financed, estimate its cost of capital.

3. Your firm is planning to invest in an automated packaging plant. Harburtin Industries is an all-equity firm that specializes in this business. Suppose Harburtin's equity beta is 0.85, the risk-free rate is 5%, and the market risk premium is 4%.

a. If your firm's project is all-equity financed, estimate its cost of capital. After computing the project's cost of capital you decided to look for other comparables to reduce estimation error in your cost of capital estimate. You find a second firm, Thurbinar Design, which is also engaged in a similar line of business. Thurbinar has a stock price of $20 per share, with 15 million shares outstanding. It also has $100 million in outstanding debt, with a yield on the debt of 4.5%. Thurbinar's equity beta is 1.00.

b. Assume Thurbinar's debt has a beta of zero. Estimate Thurbinar's unlevered beta. Use the unlevered beta and the CAPM to estimate Thurbinar's unlevered cost of capital.

c. Estimate Thurbinar's equity cost of capital using the CAPM. Then assume its debt cost of capital equals its yield and using these results, estimate Thurbinar's unlevered cost of capital.