Chapter 10 (pages 345-348):

4

You bought a stock one year ago for $50 per share and sold it today for $55 per share. It paid a $1 per share dividend today.

a. What was your realized return?

b. How much of the return came from dividend yield and how much came from capital gain?

20

Consider two local banks. Bank A has 100 loans outstanding, each for $1 million, that it expects will be repaid today. Each loan has a 5% probability of default, in which case the bank is not repaid anything. The chance of default is independent across all the loans. Bank B has only one loan of $100 million outstanding, which it also expects will be repaid today. It also has a 5% probability of not being repaid. Explain the difference between the type of risk each bank faces. Which bank faces less risk? Why?

22

Consider the following two, completely separate, economies. The expected return and volatility of all stocks in both economies is the same. In the first economy, all stocks move togetherin good times all prices rise together and in bad times they all fall together. In the second economy, stock returns are independentone stock increasing in price has no effect on the prices of other stocks. Assuming you are risk-averse and you could choose one of the two economies in which to invest, which one would you choose? Explain.

What does the beta of a stock measure?

TABLE 10.6 Betas with Respect to the S&P 500 for Individual Stocks (based on monthly data for 2007-2012)

Company	Ticker	Industry	Equity Beta
General Mills	GIS	Packaged Foods	0.20
Consolidated Edison	ED	Utilities	0.28
The Hershey Company	HSY	Packaged Foods	0.28
Abbott Laboratories	ABT	Pharmaceuticals	0.31
Newmont Mining	NEM	Gold	0.32
Wal-Mart Stores	WMT	Superstores	0.35
Clorox	CLX	Household Products	0.39
Kroger	KR	Food Retail	0.42
Altria Group	MO	Tobacco	0.43
Amgen	AMGN	Biotechnology	0.44
McDonald's	MCD
Procter & Gamble	PG	Household Products	0.47
Pepsico	PEP	Soft Drinks	0.51
Coca-Cola	KO	Soft Drinks	0.54
Johnson & Johnson	JNJ	Pharmaceuticals	0.59
PetSmart	PETM	Specialty Stores	0.75
Molson Coors Brewing	TAP	Brewers	0.78
Nike	NKE	Footwear	0.91
Microsoft	MSFT	Systems Software	1.01
Southwest Airlines	LUV	Airlines	1.09
Intel	INTC	Semiconductors	1.09
Whole Foods Market	WFM	Food Retail	1.10
Foot Locker	FL	Apparel Retail	1.11
Oracle	ORCL	Systems Software	1.12
Amazon.com	AMZN	Internet Retail	1.13
Google	GOOG	Internet Software and Services	1.14
Starbucks	SBUX	Restaurants	1.20
Walt Disney	DIS	Movies and Entertainment	1.21
Cisco Systems	CSCO	Communications Equipment	1.23
Apple	AAPL	Computer Hardware	1.26
PulteGroup	PHM	Homebuilding	1.28
Dell	DELL	Computer Hardware	1.41
salesforce.com	CRM	Application Software	1.47
Marriott International	MAR	Hotels and Resorts	1.48
eBay	EBAY	Internet Software and Services	1.48
Coach	COH	Apparel and Luxury Goods	1.60
Macy's	M
Juniper Networks	JNPR	Communications Equipment	1.71
Williams-Sonoma	WSM	Home Furnishing Retail	1.72
Tiffany & Co.	TIF	Apparel and Luxury Goods	1.80
Caterpillar	CAT	Construction Machinery	1.85
Ethan Allen Interiors	ETH	Home Furnishings	1.95
Autodesk	ADSK	Application Software	2.14
Harley-Davidson	HOG	Motorcycle Manufacturers	2.23
Advanced Micro Devices	AMD	Semiconductors	2.24
Ford Motor	F	Automobile Manufacturers	2.38
Sotheby's	BID	Auction Services	2.39
Wynn Resorts Ltd.	WYNN	Casinos and Gaming	2.41
United States Steel	X	Steel	2.52
Saks	SKS	Department Stores	2.57

Source: CapitalIQ

27

You would like to estimate the weighted average cost of capital for a new airline business. Based on its industry asset beta, you have already estimated an unlevered cost of capital for the firm of 9%. However, the new business will be 25% debt financed, and you anticipate its debt cost of capital will be 6%. If its corporate tax rate is 40%, what is your estimate of its WACC?