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Example Test 1

1. František, a.s. is a company based in the Czech Republic and operating mainly in the Czech Republic and Russia. The table below lists the Government bond rate for local currency bonds in each of those countries, the sovereign ratings, the CDS spreads of each of those countries, and the revenues František expects to generate in each market.

Country Revenue in Billions of Koruna Local Currency Gov’t Bond Rate in Local Currency Sovereign Rating Sovereign CDS Spread
Russia 30 Rubles 12% Ba1 2.5%
Czech Rep. 70 Koruna 1.5% A1 0.5%

a. Estimate the risk-free rate in Koruna

b. Estimate the market risk premium for the company. Assume that in these countries equity is 1.5 times riskier than the government bond. Mature markets have a market risk premium of 6%. (2 points)

2. Here is information from the beta page for Alphabet, Inc. (aka Google) based on 2 years of weekly data.

Interpret the intercept of the regression. (What does it tell us about the company?)

Interpret the R2 of the regression. (What does it tell us about the company?)

3. IBM is considering an acquisition of Twitter (to augment and advertise its data mining services). You have collected the following information about the two companies:

IBM Twitter
Market Cap (in $Billion) 150 20
Debt (in $Billion) 50 0
Levered Beta 1.0 1.3

Assume both firms have a marginal tax rate of 40%.

a. Estimate the unlevered beta for IBM after the acquisition. (3 points)

b. Assume that IBM will borrow $50 billion. They will use $20 billion to buy out Twitter shareholders. They will use the rest ($30 billion) to buy back stock. Estimate the (levered) beta for IBM after the acquisition. (2 points)

Example Test 2

1. Odinsa, S.A. is a Colombian construction and infrastructure development company operating primarily in Colombia, but also in Chile and Panama, and in the Dominican Republic and other parts of the Caribbean.

Here is the Beta Regression page returned by Bloomberg for the company:

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The index used for this regression is COLCAP – a Colombian stock index. (The six largest stocks in the index constitute half of the index’s market capitalization.)

Interpret the intercept of this regression. (What is it telling us about the company?)

2. You have been given the following information:

Country Local Currency Bond Yield CDS Spread Standard Deviation in Government Bond Standard Deviation in Equity
Colombia 7.0% 1.39% 15% 35%
Chile 4.2% 0.96% 10% 20%

a. Estimate the risk-free rate in Colombian pesos.

b. Estimate the market risk premium for operations in Chile. (You may assume the market risk premium in mature markets is 5%.)

3. You have been asked to estimate a levered beta for Flatline Medical Co., a company that operates in the pharmaceutical and healthcare support service industries. You have calculated the following:

Comparable Firms
Business Estimated value (in $million) Regression Beta D/E ratio
Pharma  $1,200 1.02 15%
Services $800 0.95 35%

The company has 100 million shares outstanding, trading at $20 per share. (It has no debt.) The tax rate for all companies is 40%.

a. Estimate the levered beta for Flatline, given its current structure.

b. Now suppose Flatline has decided to sell its healthcare services division (for $800 million). In addition, it will borrow $200 million. Finally, it will pay a one-time special dividend of $600 million. (It will keep the remaining $400 million as cash for future investment needs.)

Estimate the new levered beta of the company after these changes.

Example Test 3

1. Transportes Aeromar is an airline based in Mexico City. They operate domestic passenger service in Mexico and international service to the United States. Aeromar’s revenue breakdown is summarized below along with some macroeconomic data.

Country Revenue (in million $US) Gov’t Bond Rate (in local currency) Gov’t Bond Rate (in $US) Equity Market Standard Deviation Bond Market Standard Deviation
Mexico 200 7% 5% 24% 16%
US 60 2.5% 2.5% 15% 10%

The market risk premium for the US is 5.5% and the beta for Aeromar is 1.2. Estimate the cost of equity in Mexican Pesos. (Note: Mexico’s debt is not AAA rated. You may assume that Mexico has the same bond rating in Pesos and US$.)

2. Nile.com is an internet retailor which also runs an internet services business. 75% of the company’s revenue comes from sales and the rest from services. You have estimated the following about those industries:

Industry

Average Beta Average D/E ratio
Internet Retailors 1.23 0.1
Internet Services 1.00 0.2

The company has a market capitalization of $10 billion and also has $2 billion of debt outstanding. The companies’ tax rate is 40%.

a. Estimate the levered beta for the company.

b. Nile.com has decided to acquire Total Grub, a national grocery store chain. They plan to issue $3 billion of equity and use the money to acquire Total Grub. Grocery stores have an unlevered beta of 0.5. Estimate the new levered beta of the company (after the acquisition).

Example Test 4

Here are the results of a Beta regression for Bombardier.

1a. Estimate the Jensen’s Alpha (annualized) for Bombardier during this period?

1b. Give a 67% confidence interval for this estimate of Bombardier’s Beta.

a.

2. Bombardier is considering an offer to purchase Taneja Aerospace & Aviation Ltd., an Indian Aircraft manufacturer. The Indian government has 10-year Rupee denominated bonds outstanding which are rated BBB- and have a yield to maturity of 8.3%. The default risk premium on BBB- rated bonds is 2.5%. The Indian equity markets are 1½ times as volatile as the Indian government bond. The ten-year U.S. Treasury bond yields 2% and the mature market risk premium is 6%.

Estimate the US dollar cost of equity Bombardier should use for this investment. (Use information from problem 1 if necessary.)

3. You have gathered the following information about Bombardier’s two divisions:

The average regression beta for Aerospace companies is 1.1 and the average D/E ratio of these firms is 30%. The average regression beta for Railroad companies is 1.44 and the average D/E ratio of these firms is 25%. The tax rate for all firms is 33%.

The firm’s value comes 55% from the Aerospace division and 45% from the Rail division. The market capitalization of the company is Can$8.6 billion and it has Can$5 billion in outstanding debt.

a. Estimate the levered beta for Bombardier today.

b. Suppose the company is thinking of selling the Rail division for its current value in cash. They plan to use half the money to retire debt and the other half to pay a one-time dividend to stockholders. Estimate the levered beta of the firm if they go ahead with this plan. (

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