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Attached is requirements for Beta assignment.

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Introduction to Cases and Suggested Questions BUS 172A (Investment Analysis) Table of Contents 1. BETA MANAGEMENT CO. 2 2. MARRIOTT CORP.: THE COST OF CAPITAL 3 3. MERCURY ATHLETIC: VALUING THE OPPORTUNITY 7 Submit reports in soft copies on Canvas and hard copies in class. 1 1. Beta Management Co. Product number: 292122-PDF-ENG Description A manager of a small investment company has been successfully using index funds for limited market timing. Growth has allowed her to move into picking stocks. She is considering two small and highly variable listed stocks, but is concerned about the risk that these investments might add to her "portfolio." Provides a lead-in to the CAPM. Students learn about total risk, non-diversifiable or portfolio risk, and (CAPM) beta, and calculate variability of the stocks separately, and portfolio variance with and without the stocks, to see how an extremely risky (but low-beta) stock actually reduces risk; and calculate stock betas. Assignment Questions 1. Calculate the variability (standard deviation) of the stock returns of California REIT and Brown Group during the past 2 years. How variable are they compared with Vanguard Index 500 Trust? Which stock appears to be riskiest? 2. Suppose Beta's position had been 99% of equity funds invested in the index fund, and 1% in the individual stock. Calculate the variability (by standard deviation) of this portfolio using each stock. How does each stock affect the variability of the equity investment, and which stock is riskiest? Explain how this makes sense in view of your answer to Question #1 above. 3. Perform a regression of each stock's monthly returns on the Index returns to compute the \"beta\" for each stock. How does this relate to the situation described in Question #2 above? 4. If Ms. Wolfe's sole purpose is to minimize the portfolio risk, then which stock is her choice? Caution Vanguard index fund is the same as market portfolio. When executing regression procedure do not the excess returns (raw return - riskfree rate) but use the raw returns due to the lack of risk-free return data. 2 2. Marriott Corp.: The Cost of Capital Product number: 289047-PDF-ENG Description Gives students the opportunity to explore how a company uses the Capital Asset Pricing Model (CAPM) to compute the cost of capital for each of its divisions. The use of Weighted Average Cost of Capital (WACC) formula and the mechanics of applying it are stressed. Assignment Questions 1.What is the weighted average cost of capital for Marriott Corporation? a) What risk-free rate and risk premium did you use to calculate the cost of equity? b) How did you measure Marriott's cost of debt? 2.What type of investments would you value using Marriott's WACC? 3.If Marriott used a single corporate hurdle rate for evaluating investment opportunities in each of its lines of business, what would happen to the company over time? 4.What is the cost of capital for the lodging and restaurant divisions of Marriott? a) What risk-free rate and risk premium did you use in calculating the cost of equity for each division? Why did you choose these numbers? b) How did you measure the cost of debt for each division? Should the debt cost differ across divisions? Why? c) How did you measure the beta of each division? 5.What is the cost of capital for Marriott's contract services division? How can you estimate its equity costs without publicly traded comparable companies? 3 Hints and Directions for Marriot Inc. Case **You must follow this direction and hints. A. Risk free rate to compute the cost of debt Cost of debt = + *Entire Marriott firm's ! and Lodging division Long-term (30yr) risk-free rate *Restaurant and Contract services divisions Short-term (1yr) risk-free rate The values are given in Table B on page 4. B. The after-tax cost of debt = Use t = 34%. During 1986 - 1992 The Highest average corporate tax rate was 34%. C. The weights in the WACC equation The weights to compute the WACC should be the \"target\" weights shown in Table A. D. CAPM To compute the cost of equity, you need the value of ! ! (market risk premium). Use the spread using 1926 - 1987 period as the market risk premium in Exhibit 5. Caution: which spread to use for each divisional cost of equity (CAPM)? You determine based on the match of whether the division is short-term or long-term. If you make any mistakes in this step, then the ultimate values of WACC will be misleading. E. Unlevering / Re-levering beta Background: If an equity beta is unlevered, then the result is an asset beta. If and asset bta is levered (or, re-levered), then the result is an equity beta. Caution: Unlevered beta = levered beta * (1/(1 + (D/E)*(1 - t))) Levered (or, relevered) beta = unlevered beta*(1 + (D/E)*(1 - t)) **Use t = 0 for the Unlevering/re-levering process for this case. The reason is that when you apply this to get unlevered beta for the divisions of Marriott, there is no information of tax rates for other firms. Hence, consistently t = 0 for this process. Caution: The leverage given in the case is named \"market leverage\" in Exhibit 3 is Debt/(Debt + Equity) as specified in its Footnote C. You have to covert this value into D/E for the levering and unlevering prodecures. Also, the footnote in Exhibit 3 states that \"market value leverage is the book value of 4 debt divided by the sum of the book value of debt and the market value of equity.\" The Unlevering-/levering- procedure uses the market value of D/E ratio. The reason why the debt is just book value while the equity is market value is that the relevant data to find out their market value of debts were not available. Let a = D/(D+E). Then, 1-a = E/(D+E). Hence, D/E = a/(1-a). In the case: If the equity beta (each of lodging, restaurant, contract services and entire Marriott) is not directly available, then you have to go though this un-/re-levering steps. For the entire Marriott, you cannot use the equity beta shown in Exhibit 3. You have to unlever it, and get the asset beta, using the then-current leverage (41%) and re-lever the asset beta using the target leverage shown in Table A. For the lodging and restaurant divisions, there is no information on their own equity betas or asset betas as of 1987. You have to compute the asset beta of each of these two divisions using other firms' equity betas given in Exhibit 3. Unlever each of the equity beta of other firms in the same division. When unlevering, use the leverage as of 1987. Recall the unlevered betas are asset betas. Simple average the asset betas and use it as the asset beta and re-lever the averaged asset beta to get the re-levered (equity) betas. When you re-lever, use the target leverage shown in Table A. For the contract services division, there is even no information on the equity betas of other firms. Therefore, you have infer the asset beta first and re-lever it using: The asset betas of the entire Marriott, lodging division, restaurant division are calculated in the previous steps (by you). The weights need to be calculated using their assets as of 1987 shown in Exhibit 2 for each division (for example, 2,777.4 for Lodging division, and so on) Consequently, the parts in (*) are calculated in the previous steps by you with the only unknown asset beta of contract services division. You can now solve for it and then re-lever to get the equity beta for this division using the target leverage shown in Table A. F. Hints If you follow the directions described above, then you will get the values as follows. Caution that there can be rounding errors in the values. Hence, your solutions would not be exactly the same as those shown below. 5 Marriott Lodging Restaurant Contract services WACC 12.50% Asset beta Equity beta 1.624 1.038 6 3. Mercury Athletic: Valuing the Opportunity Product number: 4050-PDF-ENG Description In January 2007, West Coast Fashions, Inc., a large designer and marketer of branded apparel, announced a strategic reorganization that would result in the divestiture of their wholly owned footwear subsidiary, Mercury Athletic. John Liedtke, the head of business development for Active Gear, a mid-sized athletic and casual footwear company, saw the potential acquisition of Mercury as a unique opportunity to roughly double the size of his business. The case uses the potential acquisition of Mercury Athletic as a vehicle to teach students basic DCF (discounted cash flow) valuation using the weighted average cost of capital (WACC). Purpose of this case From the second case you experienced the estimation of the weighted average cost of capital (WACC) for the entire firm and for divisions. Now you forecast the free cash flows to the firm (FCFFs) and estimate the value of enterprise with the WACC. Of course, you will use the WACC from this case. Assignment Questions Estimate the value of Mercury using a discounted cash flow approach and Liedtke's base case projections. [Assume that the market risk premium is 5% and the risk-free rate of 4.93%] [To calculate the WACC use the target debt to asset ratio of 0.2] **Use t = 0 for the Unlevering/re-levering process for this case. ** Use t=0.4 (40%) for WACC. WACC = w! 1 t r! + ! ! [The cash in Mercury's balance sheet is considered all operational. Recall that enterprise value + non-operating cash = firm value. Hence, in this case, enterprise value = firm value. ] [Use the two tables in the next page to answer the question.] 7 Hints and Directions for Mercury Athletic Case **You must follow this direction and hints. Report the following two tables for this case. Caution: To calculate FCFFs, you use NOPAT rather than EBIT. Terminal year = 2011 NOPAT (Net operating profit after taxes) = EBIT*(1 - tax rate) The number (9,805) is a hint. Your number may be different due to rounding errors that is acceptable. Hint About the amount of \"invested capital\