1, It is the minimum rate of return the firm has to earn on its existing assets. If the firm earns more than this, value is created.

2,I would choose to use book values for debt since it is closer to the market value than the equity book value.

4, Because interest expense is tax-deductible.

5, The primary advantage of the DCF model is its simplicity. The disadvantages are the model is applicable only to firms that pay dividends and requires a constant dividend growth rate. The share price and most recent dividend can be observed but the dividend growth rate has to be estimated. Two common methods of estimating are to use analyst’s earnings and payout forecasts or to determine some appropriate average historical growth rate from the past data.

7, Find YTM of the outstanding bonds of the firm

8, a, It only considers the dividend yield component of the required return on the equity. b,This is the current yield only and is not the promised yield to maturity. Also, is based on the book value of the liability and ignoring the taxes. c, When tax is taken into the consideration, cost of equity would be higher than the cost of debt.

Questions and Problems

1, Total weight=180(45)+140(27)=11880 weight A= (180*45)/11880=0.6818 weight B=(140*27)/11880=0.3181

2, Total =2950+3700=6650
ER=(2950/6650)(0.11)+(3700/6650)(0.15)=0.1322=13.22%

4, ER=0.14(Wx)+0.105(1-Wx)
0.124=0.14Wx+0.105-0.105Wx
Wx=0.54286
Stock X=0.54286*10000=5428.57
Stock Y=10000-5428.57=4571.43

9, a, Boom: ER=(0.07+0.15+0.33)/3=0.18333 Bust:ER=(0.13+0.03-0.06)/3=0.03333333 ER=0.183333(0.35)+0.0333333(0.65)=0.08583=8.583% b, Boom:ER=0.07(0.2)+0.15(0.2)+0.33(0.6)=0.242 Bust:ER=0.13(0.2)+0.03(0.2)-0.06(0.6)=-0.04 ER=0.242(0.35)-0.04(0.65)=0.0587 Variance=0.35(0.242-0.0587)^2+0.65(-0.04-0.0587)^2=0.018

12, betaP= (1/3)0+(1/3)1.38+(1/3)X=1 X=1.62
13,