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relative to the market?
d. Assume now that you are an undiversified investor and that you have all of your
money invested in AD Corporation. What would be a good measure of the risk that you
are taking on? How much of this risk would you be able to eliminate if you diversify?
e. AD is planning to sell off one of its divisions. The division under consideration has
assets which comprise half of the book value of AD Corporation, and 20% of the market
value. Its beta is twice the average beta for AD Corp (before divestment). What will the
beta of AD Corporation be after divesting this division?


13. You run a regression of monthly returns of Mapco Inc, an oil and gas producing firm, on the
S&P 500 index and come up with the following output for the period 1991 to 1995.
Intercept of the regression = 0.06%
X-coefficient of the regression = 0.46
Standard error of X-coefficient = 0.20
R squared = 5%
There are 29.5 million shares outstanding, and the current market price is $ 53. The firm has $
753 million in debt outstanding. (The firm has a tax rate of 36%)
a. What would an investor in Mapco's stock require as a return, if the T.Bond rate is 6%?
b. What proportion of this firm's risk is diversifiable?

c. Assume now that Mapco has three divisions, of equal size (in market value terms). It plans to
divest itself of one of the divisions for $ 20 million in cash and acquire another for $ 50 million
(It will borrow $ 30 million to complete this acquisition). The division it is divesting is in a
business line where the average unlevered beta is 0.20, and the division it is acquiring is in a
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business line where the average unlevered beta is 0.80. What will the beta of Mapco be after this
acquisition?

14. You have just run a regression of monthly returns of American Airlines (AMR) against the
S&P 500 over the last five years. You have misplaced some of the output and are trying to derive
it from what you have.
a. You know the R squared of the regression is 0.36, and that your stock has a variance of 67%.
The market variance is 12%. What is the beta of AMR?
b. You also remember that AMR was not a very good investment during the period of the
regression and that it did worse than expected (after adjusting for risk) by 0.39 % a month for the
five years of the regression. During this period, the average riskfree rate was 4.84%. What was
the intercept on the regression?

c. You are comparing AMR Inc. to another firm which also has an R squared of 0.48. Will the
two firms have the same beta? If not, why not?

15. You have run a regression of monthly returns on Amgen, a large biotechnology firm, against
monthly returns on the S&P 500 index, and come up with the following output “
R2 = 0.20
Rstock = 3.28% + 1.65 RMarket
The current one-year treasury bill rate is 4.8% and the current thirty-year bond rate is 6.4%. The
firm has 265 million shares outstanding, selling for $ 30 per share.
i. What is the expected return on this stock over the next year?
ii. Would your expected return estimate change if the purpose was to get a discount rate to
analyze a thirty-year capital budgeting project?
iii. An analyst has estimated, correctly, that the stock did 51.10% better than expected, annually,
during the period of the regression. Can you estimate the annualized riskfree rate that she used
for her estimate?

iv. The firm has a debt/equity ratio of 3%, and faces a tax rate of 40%. It is planning to issue $2
billion in new debt and acquire a new business for that amount, with the same risk level as the
firm's existing business. What will the beta be after the acquisition?
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16. You have just run a regression of monthly returns on MAD Inc., a newspaper and
magazine publisher, against returns on the S&P 500, and arrived at the following result “
RMAD = “ 0.05% + 1.20 RS&P
The regression has an R-squared of 22%. The current T.Bill rate is 5.5% and the current
T.Bond rate is 6.5%. The riskfree rate during the period of the regression was 6%..
Answer the following questions relating to the regression “
a. Based upon the intercept, you can conclude that the stock did
A. 0.05% worse than expected on a monthly basis, during the regression.
B. 0.05% better than expected on a monthly basis during the period of the
regression
C. 1.25% better than expected on a monthly basis during the period of the
regression.
D. 1.25% worse than expected on a monthly basis during the period of the
regression.
E. None of the above. (1 point)

b. You now realize that MAD Inc went through a major restructuring at the end of last
month (which was the last month of your regression), and made the following changes “
The firm sold off its magazine division, which had an unlevered beta of 0.6, for $ 20

million.
It borrowed an additional $ 20 million, and bought back stock worth $ 40 million.

After the sale of the division and the share repurchase, MAD Inc. had $ 40 million in debt
and $ 120 million in equity outstanding.
If the firm™s tax rate is 40%, re-estimate the beta, after these changes.

17. Time Warner Inc., the entertainment conglomerate, has a beta of 1.61. Part of the reason for
the high beta is the debt left over from the leveraged buyout of Time by Warner in 1989, which
amounted to $10 billion in 1995. The market value of equity at Time Warner in 1995 was also $
10 billion. The marginal tax rate was 40%.
a. Estimate the unlevered beta for Time Warner.
b. Estimate the effect of reducing the debt ratio by 10% each year for the next two years on the
beta of the stock.
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18. Chrysler, the automotive manufacturer, had a beta of 1.05 in 1995. It had $ 13 billion in debt
outstanding in that year, and 355 million shares trading at $ 50 per share. The firm had a cash
balance of $ 8 billion at the end of 1995. The marginal tax rate was 36%.
a. Estimate the unlevered beta of the firm.
b. Estimate the effect of paying out a special dividend of $ 5 billion on this unlevered beta.
c. Estimate the beta for Chrysler after the special dividend.

19. You are trying to estimate the beta of a private firm that manufactures home appliances. You
have managed to obtain betas for publicly traded firms that also manufacture home appliances.
Firm Beta Debt MV of Equity
Black & Decker 1.40 $ 2,500 $ 3,000
Fedders Corp. 1.20 $5 $ 200
Maytag Corp. 1.20 $ 540 $ 2250
National Presto 0.70 $8 $ 300
Whirlpool 1.50 $ 2900 $ 4000
The private firm has a debt equity ratio of 25%, and faces a tax rate of 40%. The publicly traded
firms all have marginal tax rates of 40%, as well.
a. Estimate the beta for the private firm.
b. What concerns, if any, would you have about using betas of comparable firms?

20. As the result of stockholder pressure, RJR Nabisco is considering spinning off its food
division. You have been asked to estimate the beta for the division, and decide to do so by
obtaining the beta of comparable publicly traded firms. The average beta of comparable publicly
traded firms is 0.95, and the average debt/equity ratio of these firms is 35%. The division is
expected to have a debt ratio of 25%. The marginal corporate tax rate is 36%.
a. What is the beta for the division?
b. Would it make any difference if you knew that RJR Nabisco had a much higher fixed cost
structure than the comparable firms used here?

21. Southwestern Bell, a phone company, is considering expanding its operations into the media
business. The beta for the company at the end of 1995 was 0.90, and the debt/equity ratio was 1.
The media business is expected to be 30% of the overall firm value in 1999, and the average beta
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of comparable firms is 1.20; the average debt/equity ratio for these firms is 50%. The marginal
corporate tax rate is 36%.
a. Estimate the beta for Southwestern Bell in 1999, assuming that it maintains its current
debt/equity ratio.
b. Estimate the beta for Southwestern Bell in 1999, assuming that it decides to finance its media
operations with a debt/equity ratio of 50%.

22. The chief financial officer of Adobe Systems, a growing software manufacturing firm, has
approached you for some advice regarding the beta of his company. He subscribes to a service
which estimates Adobe System™s beta each year, and he has noticed that the beta estimates have
gone down every year since 1991 - 2.35 in 1991 to 1.40 in 1995. He would like the answers to
the following questions “
a. Is this decline in beta unusual for a growing firm?
b. Why would the beta decline over time?
c. Is the beta likely to keep decreasing over time?

23. You are analyzing Tiffany™s, an upscale retailer, and find that the regression estimate of the
firm™s beta is 0.75; the standard error for the beta estimate is 0.50. You also note that the average
unlevered beta of comparable specialty retailing firms is 1.15.
a. If Tiffany™s has a debt/equity ratio of 20%, estimate the beta for the company based upon
comparable firms. (The tax rate is 40%)
b. Estimate a range for the beta from the regression.
c. How would you reconcile the two estimates? Which one would you use in your analysis?

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