PROBLEMS: 1. Cost of Equity. The following table shows estimates of the risk of two well-known Canadian stocks: Sun Life Financial Loblaw R? 0.12 0.06 Beta 0.86 0.63 Standard Error of Beta 0.30 0.33 a. What proportion of each stock's risk was market risk? b. What is the expected return on Sun Life? Assume a risk-free interest rate of 5% and an expected market rate of 12%. C. Suppose that next year, the market provides a 20% return. Knowing this, what return would you expect from Loblaw? Also assume a risk-free interest rate of 5%. 2. WACC. A company is 40% financed by risk-free debt. The interest rate is 10%, the expected market risk premium is 8%, and the beta of the company's common stock is 0.5. What is the after tax WACC, if the company pays tax at a 20% rate? 3. Asset Beta. EZCUBE Corp. is 50% financed with long-term bonds and 50% with common equity. The debt securities have a beta of 0.15. The company's equity beta is 1.25. What is EZCUBE's asset beta? 4. WACC. Calculate the WACC for Federated Junkyards of America using the following information: - Debt: $67,500,000 market value. The yield to maturity is 9%. Equity: 2,500,000 shares selling at $42 per share. Assume the expected rate of return on Federated J's stock is 18%. Taxes: Federated J's marginal tax rate is Tc = 0.21. 5. Adjusting WACC. Suppose Federated Junkyards decides to move to a more conservative debt policy. A year later, its debt ratio is down to 15%. The interest rate has dropped to 8.6%. Recalculate Federated J's WACC under these new assumptions. The company's business risk, opportunity cost of capital, and tax rate have not changed. Use the three-step procedure in adjusting WACC (as presented in the lecture - Cost of Capital Part2)