MATH 246 Midterm: Exam 3 Solutions
14 Mar 2019
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You are an entrepreneur with a potential project. The following spreadsheet reports expected unlevered cash flows for the project. This project has the same economic risk as the unlevered cash flows of widgets, inc. (hereafter called wi. ) The market value of wi stock is mm. The current market value of what wi owes debtholders is mm. Wi attempts to keep the ratio of its net debt to equity constant over time. The market beta of wi"s equity is 1. 4. The market beta of wi"s debt is 0. 2. The expected return to the overall stock market is 8 percent. Use the capm to calculate expected returns to debt and equity. Expected return = riskfree rate + beta* (expected return to market minus riskfree rate) Expected return = 3% + beta*(8% - 3%) = 3% + beta*5% Therefore the expected return to equity is re = 3%+1. 4*5% = 10%. The expected return to debt is rd = 3% + 0. 2*5% = 4%
