Question
(I) A project manager is trying to ascertain a discounting rate for the project cash flows that carry the same risk as the core business
(I) A project manager is trying to ascertain a discounting rate for the project cash flows that carry the same risk as the core business of the firm. The manager has been told by the finance team at the firm that the current capital structure has a debt to value ratio of 0.3, however, they are targeting a ratio of 0.25 to get a better credit rating. The better credit rating would reduce the cost of debt to 7%. The currentreturn on the firm's equity is 15% and the current cost of debt is 8%. Whatis an appropriate discountrate forthe project cash flowsifthetax rate is 25%?
(II) Afirmhas a currentmarketvalueofINR250 crores. The current costof equity is 15%and the tax rate is 20 percent. If the firm has announced to issue a per- petual debt of INR 50 crores at 6% interest rate to change the capital structure of the firm, what is the market value ofthe firmafterthis announcement?
(III) AfirmusesINR50million of debt,INR15million ofshort-termdebt, and INR 90million of common equity to finance its assets. If the before-tax cost of debt is 10%, after-tax cost of short-term debt is 8%, and the cost of common equity is 16%, calculate the weighted averagecostofcapitalforthefirmassumingatax rate of 20%.
(IV) Expected return of stock Alpha is 8 percent and of stock Beta is 12 percent. The standard deviation of the stocks are 13 percent and 18 percent respectively. The correlation between these two stocks is 0.4. If the portfolio manager has decided to invest all the funds that he holdsin some proportion in these two assets. The expected return ofthe portfolio based on this proportion is 11.5%. What are the weightsin each of the stocks? What isthe standard deviationofthisportfolio?
(V) The Sharpe ratio of an asset Alpha is 0.8. Alpha has and expected return of 12% and a standard deviation of 20%. Youhavebeen tasked to arrive at the expected return of an asset Gamma. Themarketreturn in this economy is 14% and the beta (systematic risk) of Gamma with market return is 1.4. What is the expected return of asset Gamma?
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