Unless mentioned otherwise, assume:

1) EBIT is a level perpetuity.

2) Tax rate is zero.

3) Market is efficient.

4) CAPM is valid.

5) Bonds are perpetual.

Prob1) IBM has a beta of 1. Expected return is 12%Boeing has a beta of 2. Expected return is 19%.Find the risk-free rate.

Prob2)

Oracle has a beta of 2. Market risk Premium, (RM - RF), is 9%. Risk free rate is 7%. You invest 50% of your money in Oracle and 50% in a risk-free T-bond.a) Find the expected rate of return on this portfolio.

b) Find the beta of this portfolio.

Prob3)You own some shares of Microsoft worth $1,000. Beta of Microsoft is 2. Microsoftcurrently has no debt. Microsoft decides to issue debt and buy back some of its stock inopen market. Specifically, Microsoft decides to buy back 20% of its stock using ALL theproceeds of a new issue of risk-free bonds. Corporate tax rate is zero. You decide to notsell any part of your shares.

a) What is the value of your shares after the buyback is completed.

b) What is the beta of your shares after the buyback is completed.

c) After the company is levered, you decide to sell some of your shares and invest theproceeds in risk-free bonds. You want to do this rebalancing so that your portfolio (shares+bonds) will have the same beta as the unlevered shares (beta of 2). Effectively,you want to undo the leverage of Microsoft. What fraction of your money will beinvested in risk-free bonds?

Prob4)

You are the new CFO of Megasoft. Megasoft has $ 1billion market value. It currentlyhas no debt. Corporate tax rate is 40%. You make a compelling argument to the boardthat debt will enhance shareholder value. The board authorizes you to issue risk-free debt and buyback some stock using ALL theproceeds of debt. The board wants the post-leverage capital structure to have exactly

20% debt (B/VL=0.2). You will soon make an announcement to the shareholders aboutyour plans to issue debt and buyback some stock.a) How much debt will you need? (Be careful. As soon as the announcement ismade, the stock will go up to reflect the benefits of debt. VL=VU+TB. You need

enough B to buy back 20% of VL . )

b) Suppose you owned $ 1,000 worth of shares before the announcement. What willbe the value of your shares after Megasoft is levered. Assume that you dont sell any shares.

Prob5) Global Works Inc.(GWI) is an all equity firm, currently worth $ 100 million. Costof equity capital is 20%. The CFO has pitched an exciting idea to the board. She astutelypoints out that GWI can borrow at a much lower rate than its cost of equity capital. Thisis correct. In abundance of caution, the board has asked you to evaluate the wisdom of theidea, specifically borrow $ 20 mil and use the proceeds to buy back some of the stock inorder to lower the cost of capital. For now, use WACC as a metric for decision. Assumethe tax rate is zero. Show the board the following:

5a) Rwacc after buyback _______

5b) Value of remaining equity after buyback_______

Note: I have provided sufficient information to answer this question. Although theanswers are quite straight forward, this will give you an opportunity to develop someintuition.