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Part C: Cost of Capital and Capital Market Efficiency Questions/Problems Use the following information for the question(s) below. Your firm is considering building a
Part C: Cost of Capital and Capital Market Efficiency Questions/Problems Use the following information for the question(s) below. Your firm is considering building a casino, and you are trying to determine the cost of capital in the industry. You have collected the following information on firms in the casino industry. Company Beta MGM Mirage 1.10 Mandalay Resort Group 0.95 Caesars Entertainment 1.20 Stock Price $72.67 $70.43 $19.88 # of Shares 143 million 65 million 304 million Debt $5.6 billion $3.0 billion $4.6 billion The risk-free rate is 5%, and the historical market risk premium, (E[Rmkt]-T), is 6%. [Q1] What is the equity cost of capital for an unlevered firm in the industry? [Q2] What is the equity cost of capital for a firm in the industry with a debt-to-equity ratio of 1? Use the following information for the question(s) below. Nordstrom is spinning off its casual clothing segment and you are trying to determine the value of the spun-off entity. You estimate that the division's free cash flow in the coming year to be $100 million, and you expect the free cash flows will grow by 3% per year in subsequent years. Because the spin-off isn't publicly traded yet, you do not have an accurate assessment of the division's equity beta. However, you do have beta data for Gap, Inc., a firm it closely resembles. Gap has an equity beta of 1.1, a debt beta of 0, and a debt-equity ratio of 0.20. Nordstrom has a beta of 2.2, a debt-equity ratio of 1.0 (the spun-off firm will maintain this leverage ratio), and has been told by its investment bankers that the debt cost of capital will be 6%. The corporate tax rate is 40%, the risk-free rate is 5%, and the historical market risk premium, (E[Rmkt]-1+), is 6%. [Q3] Estimate the spun-off division's WACC. Is the spun-off division's WACC equal to 15%? If it is not, how may using a WACC of 15% affect their corporate investment decision making? [Q4] Estimate the spun-off unit's share value based on the 100 million shares that will be outstanding after the spin-off. Use the following information for the question(s) below. Suppose that a firm with a stock price of $80 just announced that it expects to pay a $100 per share liquidating dividend in 1 year, although the exact amount of the dividend depends on the performance of the company this year. Assume that the CAPM is a good description of stock price returns and that the stock's beta is 1.5, the market's expected return is 12%, and the risk-free rate is 5%. [Q5] Is the stock priced correctly now? [Q6] What is the alpha of the stock? [Q7] What would you expect to happen to the stock price in an efficient market after the announcement?
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