Finance Case: Beta and cost of CapitalDeadline: WEEK 4IMPORTANT:You have to hand in the assignment in week 4 in the black mailbox on the fourth floor of the E-building next to the secretarial office (E4.26) at the latest at. DO NOT HAND IT IN BY EMAIL! Solutions should be clearly typed. Only one copy is required per group, and it should not be more than 3 pages. Recall that one group should contain 3-4 students. Write the course code and the name and student number of each student in the group on the front page and the exact day and time of your tutorial class. Make sure that you provide intermediate steps in your presentation of results so that one can follow how you ended up with the final result. Only use the material provided on Blackboard (except for question 5). Please remember: plagiarism is a serious offence and its perpetrators will face sanctions.The first goal of this assignment is to estimate the cost of capital for 3 Dutch companies listed at the NYSE Euronext Amsterdam. In this assignment you will analyze the cost of capital of ING, ASML and Ahold at 31-12-2010.The necessary data file (Dataset Assignment 1.xls) can be downloaded from the blackboard site. This file contains the stock market prices of the 3 companies and a stock market index, the AEX. Prices in this file already reflect dividends! Hence you may ignore the effect of dividends in calculating returns. Balance sheet information is included in the file: Balance Sheets.pdf. Use these data to answer the following questions.Question 1a) Using monthly data, estimate the equity betas over the period January 1, 2006 until December 31, 2010 of ING, ASML and Ahold.Hint: do not forget to calculate rates of return first!b) The AEX index consists of only 25 companies, whereas the FTSE (UK) contains 100 and the S&P (US) contains 500. Ceteris paribus, what would you expect to happen to the beta of a company when the index in which it is contained consists of fewer stocks? Why?Question 2The betas that youâ€™ve estimated in Question 1) are levered equity betas. To determine project risk we are more interested in the unlevered equity betas or asset betas. Based on the information you have in Question 1) plus the specific capital structures (see Balance Sheets.pdf), estimate for each of the 3 companies the asset beta. Assume initially that beta debt is zero and ignore the impact of taxes.(Use in this question as a proxy for debt: Net Debt = Interest Bearing Debt â€“ Cash and Cash Equivalents)Question 3a) Interpret the asset betaâ€™s of ASML and Ahold on the basis of the fundamental drivers of asset beta.b) Now examine the equity beta and the asset beta of ING and comment on their values. Do you consider them high/low? Try to come up with an explanation.Question 4a) Until now we have assumed that beta of debt is zero. For which of these three firms is this a reasonable assumption, for which not?b) Assume that debt of each firm has a beta equal to 0.1. Recalculate the asset beta of each firm (but assume there are still no taxes).c) Now assume that Ahold increases its debt to value ratio to 50%. What will happen to Aholdâ€™s equity beta? Motivate with a calculation. What will happen to its asset beta?In the next part we will look at the cost of capital. The objective is to estimate the weighted average cost of capital (WACC):This WACC plays an important role in modern corporate finance, so understanding its underpinnings is of the utmost importance. To determine the WACC one needs the required rate of return on equity as well as on debt. Also the capital structure is needed as an input. To determine the cost of equity and the cost of debt in a CAPM framework, the risk free rate, the betas and the market risk premium are needed.Question 5Determine the risk free rate on December 31, 2010 by considering a maturity of 10 years. Explain carefully where this number came from.(Hint: Use the Internet, newspapers or DataStream)Question 6Assume the market risk premium is 4% and use your answer found in the previous question as a risk free rate to estimate the cost of equity for each of the three companies. Question 7Now calculate the WACC for each of the three companies (still ignoring the impact of taxes). Assume that the beta of debt is equal to 0.1.Question 8The WACC in the case where there are no taxes is independent of the relative proportions of debt and equity. a) Explain why this is the case.Give the most important advantage and disadvantage of taking on debt from the perspective of the firm.Assume the corporate tax rate is 40%. Calculate the after tax WACC for each of the three companies.
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