Question

1. As of late April the US risk-free rate is approximately 1%. Assume for the moment that market risk is 7% due to the pandemic. Answer the following questions:

1. What is the required return for the company you used for the financial analysis project? Show your calculations.
2. The risk-free rate and market risk above define a Security Market Line (SML). If the risk-free rate were to rise to 1.5% next month, how would that change the SML? Explain your answer.
3. Assume instead of the change in B that the market risk declined to a more normal 5% by September. How would that change the SML defined by the original conditions? Explain your answer.

2. ABC Corp was created from the combination of two smaller companies two years ago. Selected information is as follows, in millions except percentages:

FCF current year: $215

WACC: 8.5%

Constant growth rate: 3%

Short-term investments: $18

Debt: $47

Preferred stock: $10

Number of common stock shares: 12

1. Show calculations for ABC’s value of operations.
2. Show calculations for ABC’s estimated intrinsic stock price.
3. Which would have the larger effect on your answer in B, a $10 increase in FCF or a 1% decrease in WACC? Show calculations.

Answer 1

2.) answer:

a)Formula to find the firm's value

whre FCFF1 = FCFF0(1+g)

Firm Value = $215 (1+0.03)/ 0.085-0.03 = 4026.364

b) intrinsic value of stock price = Firm Value/no. of shares

4026.364/12 = 335.5303 approx.

c) when $10 is increased in FCF

Inrinsic value of stock price = Firm value / shares =

[225(1+0.03)] /[ 0.055 * 12] = 351.1364

When Wacc is reduced by 1%

Value of stock (formula is same) = [215*1.03]/[12*0.045] = 410.0926

note: 0.045 = 0.075-0.03

we can clearly see that value of the stock is most affected by change in WACC

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