Question $318$ Marks

Stock X has a $10\%$ expected return, a beta coefficient of $0\mathrm{.}9,$ and a $35\%$ standard deviation of expected

returns. Stock Y has a $12\mathrm{.}5\%$ expected return, a beta coefficient of $1\mathrm{.}2,$ and a $25\%$ standard deviation.

The risk$-$free rate is $6\%,$ and the market risk premium is $5\%.$

Required:

$3\mathrm{.}1.$ Calculate each stock$$s coefficient of variation. $(2)$

$3\mathrm{.}2.$ Which stock is riskier for a diversified investor? $(3)$

$3\mathrm{.}3.$ Calculate each stock$$s required rate of return. $(2)$

$3\mathrm{.}4.$ On the basis of the two stocks$$ expected and required returns, which stock would be more

attractive to a diversified investor? $(4)$

$3\mathrm{.}5.$ Calculate the required return of a portfolio with R$7,500$ invested in Stock X and R$2,500$ invested

in Stock Y$.(4)$

$3\mathrm{.}6.$ If the market risk premium increased to $6\%,$ which of the two stocks would have the larger

increase in its required return? $(3)$

Question $415$ Marks

Apilado Appliance Corporation is considering a merger with the Vaccaro Vacuum Company. Vaccaro is

a publicly traded company, and its current beta is $1\mathrm{.}30.$ Vaccaro has been barely profitable, so it has

paid an average of only $20\%$ in taxes during the last several years. In addition, it uses little debt, having

a debt ratio of just $25\%.$

If the acquisition were made, Apilado would operate Vaccaro as a separate, wholly owned subsidiary.

Apilado would pay taxes on a consolidated basis, and the tax rate would therefore increase to $35\%.$

Apilado also would increase the debt capitalization in the Vaccaro subsidiary to $40\%$ of assets, which

would increase its beta to $1\mathrm{.}47.$ Apilado$$s acquisition department estimates that Vaccaro, if acquired,

would produce the following cash flows to Apilado$$s shareholders $($in millions of rands$)$:

Year Cash Flows

$1$ R$1\mathrm{.}30$

$2$ R$1\mathrm{.}50$

$3$ R$1\mathrm{.}75$

$4$ R$2\mathrm{.}00$

$5$ and beyond Constant growth at $6\%$

These cash flows include all acquisition effects. Apilado$$s cost of equity is $14\%,$ its beta is $1\mathrm{.}0,$ and its

cost of debt is $10\%.$ The risk$-$free rate is $8\%.$

Required:

$4\mathrm{.}1.$ What discount rate should be used to discount the estimated cash flows? $($Hint: Use Apilado$$s rs

to determine the market risk premium.$)(5)$

MBA$5903$

MAY$/$JUNE $2022$ SPECIAL EXAMINATION

$6$

$4\mathrm{.}2.$ What is the rand value of Vaccaro to Apilado? $(4)$

$4\mathrm{.}3.$ Vaccaro has $1\mathrm{.}2$ million common shares outstanding. What is the maximum price per share that

Apilado should offer for Vaccaro? If the tender offer is accepted at this price, what will happen to

Apilado$$s stock price?Stock X has a $10\%$ expected retum, a beta coefficlent of $0\mathrm{.}9,$ and a $35\%$ standard devlation of expected

returns. Stock Y has a $12\mathrm{.}5\%$ expected return, a beta coefficient of $1\mathrm{.}2,$ and a $25\%$ standard deviation.

The risk$-$free rate $156\%,$ and the market risk premlum is $5\%.$

Requlred:

$3\mathrm{.}1.$ Calculate each stock's coefficient of variation.

$3\mathrm{.}2.$ Which stock is riskler for a dlversifled Investor?

$3\mathrm{.}3.$ Calculate each stock's requlred rate of retum.

$3\mathrm{.}4.$ On the basls of the two stocks' expected and required retumi, which stock would be more

attractive to a diversined Investor?

$3\mathrm{.}5.$ Calculate the requlred return of a portfollo with $R7,500$ Invested in Stock $x$ and $R2,500$ Invested

In Stock $Y.$

$3\mathrm{.}6.$ If the market risk premlum Increased to $6\%,$ which of the two stocks would have the larger

Increase in its requlred return?

Questlon $4$

$15$ Marks

Apllado Appllance Corporation Is considering a merger with the Vaccaro Vacuum Company. Vaccaro is

a publlcly traded company, and its current beta is $1\mathrm{.}30.$ Vaccaro has been barely profitable, $s0$ it has

pald an average of only $20\%$ In taxes during the last several years. In addltion, It uses Ilttle debt, having

a debt ratio of just $25\%.$

If the acquisition were made, Apllado would operate Vaccaro as a separate, wholly owned subsidlary.

Apllado would pay taxes on a consolldated basls, and the tax rate would therefore increase to $35\%.$

Apllado also would Increase the debt capitalzation In the Vaccaro subsidlary to $40\%$ of assets, which

would Increase its beta to $1\mathrm{.}47.$ Apllado's acquisition department estimates that Vaccaro, If acqu$/$red$,$

would produce the following cash flows to Apllado's shareholders $($In milllons of rands$)$:

These cash fows Include all acqu$/$sition effects. Apllado's cost of equity is $14\%,$ its beta is $1\mathrm{.}0,$ and its

cost of debt is $10\%.$ The risk$-$free rate $158\%.$

Requlred:

$4\mathrm{.}1.$ What discount rate should be used to dlscount the estimated cash fows? $($Hint: Use Apllado's rs

to determine the market risk premlum.$)$