Question 1You are the financial manager of Costco Wholesale Corporation (symbol: COST) and are considering thepurchase of a local grocery chain in the US northeast. COST will benefit by not only receiving the netcash flows generated by this company, but also via synergies produced by having the companiescombine forces. You want to figure out the maximum you are willing to pay for this grocery chain.COST has determined that the hypothetical cash flows generated by this purchase would be of similarriskiness to its own total asset cash flows. Therefore, COST will use its asset expected return to discountthe future net cash flows it expects to receive from this local grocery chain. Your challenge is to calculateCOST?s asset expected return, which will be used as the local grocery chain?s discount rate (we willignore any tax effects on the discount rate).a) First, calculate COST?s equity beta. Go to Yahoo! Finance and click on ?Historical Data? for COST.Click on ?Historical Prices? and download monthly COST price data from August. 1, 2013 toAugust 1, 2016. Do the same for the S&P500 (symbol: ^GSPC), our underlying proxy for themarket portfolio.Next, calculate monthly returns for COST and the S&P500 using the equation:???????? = (???????? ? ?????????1)??????????1, where ????????is the return in month t, and ????????is the adjusted closing price inmonth t. When calculating returns, make sure your data are sorted so that time is in ascendingorder, not the default descending order. Convert all of your returns into excess returns (???????? ? ????????)by subtracting the monthly risk-free rate, which we will assume as 0.024/12. You will not have areturn observation for the first month of your time series.Then, run a linear regression of COST excess returns (your Y variable) on S&P500 excess returns(your X variable). You can find ?Regression? in Microsoft Excel in ?Data Analysis? under the?Data? tab.1If the X-variable coefficient is positive and statistically significant (t-statistic greater than 1.95),then we conclude (with 95% confidence) that if S&P500 returns are 1 percent higher, then COSTreturns are (Coefficient multiplied by 1 percent) higher.Report the X-variable coefficient along with its t-statistic. The X-variable coefficient is the equitybeta for COST. This was derived by fitting data to the CAPM.1If ?Data Analysis? does not appear, do the following: click ?File?, then ?Options?, then ?Add-Ins?, then click the?Go? button. Check the ?Analysis ToolPak? box and click OK. ?Data Analysis? should then appear in the ?Data? tab.b) Next, we need COST?s market values of debt and equity. Go back to the COST page in Yahoo!Finance. The market value of equity is also known as ?market capitalization? and can be foundon the ?Summary? page.To find the market value of debt, click on ?Financials? and then ?Balance Sheet? to obtain COST?s?Total Liabilities? from August 30, 2015 (keep in mind that all financial statement items arereports in thousands of dollars). Because COST?s debt is fairly stable, it is safe to assume that thebook value of debt equals the market value of debt. Because COST?s debt is considered very lowrisk, we will assume COST?s debt beta equals 0.05.Report the market value of equity and the market value of debt for COST.c) Using the information from parts (a) and (b), calculate the asset beta for COST. Show yourworkings.d) Using the CAPM, calculate and report the expected return for COST?s assets. Assume a marketrisk premium of 5.0% and a risk-free rate of 2.4% (the approximate yield on 30-year U.S.treasury securities). Show your workings.You expect this acquisition to generate its first cash flow next year and that it will be equal to 0.10percent of your firm?s cash flows provided by operating activities in the 2015 cash flow statement (thecash flow statement can be found by clicking on ?Financials? and then ?Cash Flow?). Forecasts informyou that these cash flows generated by this acquisition will grow by 0.50 percent per year thereafter,and that you will receive the cash flows in perpetuity.e) What is the maximum you would be willing to pay for this local grocery chain? That is, what isthe fair value of this local grocery chain, according to your calculations?Question 2You are an original owner of a publicly traded food service company called Smith?s Foods (SF). Yourcompany has been in the high-end restaurant business (HE) for the past ten years. You announced todaythat the company will be issuing debt today to open a new fast food division (FF).Opening this new division costs $8M today, which you will fund by issuing debt. Revenues from this newdivision are expected to be $4M next year and are projected to grow by 2 percent per year. Costs fromthis new division are expected to be $3M next year and are projected to grow by 1 percent per year. Thelife of this project is 20 years.Analysis of other fast food businesses suggests that the beta of a fast food division equals 0.60. Assumethat the revenues and costs have similar risk. Throughout this problem, assume a risk-free rate of 3percent and a market risk premium of 6 percent.a) What is the NPV of this new investment? Is it a good investment? Hint: you will need to use thegrowing annuity formula twice. Once for revenues and once for costs.A regression of monthly SF excess stock returns on monthly S&P 500 excess returns from the past tenyears tells you that the beta of the high-end division equals 1.5. Directly before the investment in thefast food division, SF was an all-equity firm with 1M shares outstanding trading at $25 per share, whichrepresents the value of the high-end division. Assume that the announcement of the new division doesnot affect the value or beta of the high-end division.b) What is the beta of the firm after the announcement of the new division? The beta of a firm canbe calculated as the value-weighted average of the division betas:???????????????????? =????????1????????1 + ????????2????????1 +????????2????????1 + ????????2????????2where the value of a division (????????1 or ????????2) equals the present value of its future net cash flows(when calculating the value of the fast food division, do not subtract the initial $8M cost, as thiswas paid for using newly-issued debt).c) Assume that the beta of the new debt (valued at $8M) is equal to 0.1. What is the beta of thefirm?s equity after the announcement of the new division?d) The beta of your firm?s equity was originally 1.5. There are two reasons why the announcementcaused the beta of your firm?s equity to slightly change ? one reason caused the original beta todecrease while the other caused it to increase. Briefly explain these reasons.e) What is the change in the expected return of the firm due to the announcement?Question 3Your company announces that it will pay out a constant annual dividend of $2.00 per share for the nextten years. Following that, the dividend will grow at 4 percent per year and will be paid out in perpetuityat this growth rate (for example, the dividend at t=11 will be $2.00 x 1.04 = $2.08 per share). Thecompany has an equity beta of 1.25. Assume a risk-free rate of 2.5 percent and a market risk premium of6 percent.a) Based on the information provided above, what is the correct price per share for your companytoday?b) You would like to calculate the beta of your company?s assets, in order to get an idea of thesensitivity of your business operations to market conditions. Your company currently has 5Mcommon shares outstanding, and 50K bonds outstanding priced at $900 per bond. These bondsare fairly low risk, so you think a beta of 0.05 is a reasonable assumption for these bonds. Giventhis information and your calculation in part (a), what is the beta of your company?s assets?c) Following this calculation, you realize that $35M of your company?s assets consist of riskless U.S.Treasury bonds, with the remainder consisting of the company?s operating assets. What is thebeta of your company?s operating assets?Hint: use the formula provided in Question 2(b), with one ?division? being the Treasury bondholdings and the other ?division? being the operating assets. Also keep in mind that the value ofthe company?s assets equals the value of the company?s operating assets plus the value of theTreasury bonds held by the company.

Finance 320 Problem Set 1 Due: Sept. 9, 2016 Question 1 You are the financial manager of Costco Wholesale Corporation (symbol: COST) and are considering the purchase of a local grocery chain in the US northeast. COST will benefit by not only receiving the net cash flows generated by this company, but also via synergies produced by having the companies combine forces. You want to figure out the maximum you are willing to pay for this grocery chain. COST has determined that the hypothetical cash flows generated by this purchase would be of similar riskiness to its own total asset cash flows. Therefore, COST will use its asset expected return to discount the future net cash flows it expects to receive from this local grocery chain. Your challenge is to calculate COST's asset expected return, which will be used as the local grocery chain's discount rate (we will ignore any tax effects on the discount rate). a) First, calculate COST's equity beta. Go to Yahoo! Finance and click on \"Historical Data\" for COST. Click on \"Historical Prices\" and download monthly COST price data from August. 1, 2013 to August 1, 2016. Do the same for the S&P500 (symbol: ^GSPC), our underlying proxy for the market portfolio. Next, calculate monthly returns for COST and the S&P500 using the equation: = ( 1 )1 , where is the return in month t, and is the adjusted closing price in month t. When calculating returns, make sure your data are sorted so that time is in ascending order, not the default descending order. Convert all of your returns into excess returns ( ) by subtracting the monthly risk-free rate, which we will assume as 0.024/12. You will not have a return observation for the first month of your time series. Then, run a linear regression of COST excess returns (your Y variable) on S&P500 excess returns (your X variable). You can find \"Regression\" in Microsoft Excel in \"Data Analysis\" under the \"Data\" tab.1 If the X-variable coefficient is positive and statistically significant (t-statistic greater than 1.95), then we conclude (with 95% confidence) that if S&P500 returns are 1 percent higher, then COST returns are (Coefficient multiplied by 1 percent) higher. Report the X-variable coefficient along with its t-statistic. The X-variable coefficient is the equity beta for COST. This was derived by fitting data to the CAPM. 1 If \"Data Analysis\" does not appear, do the following: click \"File\