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The purpose of this assignment is to apply principles and skills associated with rates of return.
Using what you have learned from the topic resources, complete the following problems and cases from the textbook.
- Problems and Cases 11.10
- Problems and Cases 11.12
- Problems and Cases 12.12
Prepare the assignment in Excel with each problem or case as a separate tab. All narrative questions should be fully addressed within the Excel document on the tab associated with the problem or case.
APA style is not required, but solid academic writing is expected.
This assignment uses a rubric. Please review the rubric prior to beginning the assignment to become familiar with the expectations for successful completion.
Assessment Description The purpose of this assignment is to apply principles and skills associated with rates of return. Using what you have learned from the topic resources, complete the following pr
Problems and Cases 11.10 Problems and Cases11.10 Calculating Required Rates of Return on Equity Capitalacross Different Industries. The data in Exhibit 11.3 on industry median betas sug-gest that ﬁrms in the following three sets of related industries have different degrees of system-atic risk.Median Beta during 2006–2015Utilities versus Petroleum and Natural Gas 0.75 versus 1.45Food Products (Grocery Stores) versus Apparel (Retailers) 0.78 versus 1.17Banking (Depository Institutions) versus Trading(Financial Security and Commodity Brokers) 0.88 versus 1.13REQUIREDREQUIREDa. For each matched pair of industries, describe factors that characterize a typical ﬁrm’sbusiness model in each industry. Describe how such factors would contribute to differen -ces in systematic risk.b. For each matched pair of industries, use the CAPM to compute the required rate ofreturn on equity capital for the median ﬁrm in each industry. Assume that the risk-freerate of return is 4.0% and the market risk premium is 5.0%.c. For each matched pair of industries, compute the present value of a stream of $1 dividendsfor the median ﬁrm in each industry. Use the perpetuity-with-growth model and assume 3.0%long-run growth for each industry. What effect doesthedifferenceinsystematicriskacrossindustries have on the per-dollar dividend valuation of the median ﬁrm in each industry? Problems and Cases 11.12 11.12 Calculation of Dividends-Based Value. Royal Dutch Shell (Shell) isa petroleum and petrochemicals company. It engag es primarily in the exploration, production,and sale of crude oil and natural gas and the manufacture, transportation, and sale of petro-leum and petrochemical products. The company operates in approximately 200 countries inNorth America, Europe, Asia-Paciﬁc, Africa, South America, and the Middle East. Assume thatduring the past three years (Year 2, 1, and 0), Shell generated the following total dividendsto common equity shareholders (in USD millions):Year 2 Year 1 Year 0Common dividend payments $ 8,142 $ 9,001 $ 9,516Stock repurchases 8,047 4,387 3,573Total dividends $16,189 $13,38 8 $13,089Analysts project 5% growth in earnings over the next ﬁve years. Assuming concurrent 5% growthin dividends, the following table provides the amounts that analysts project for Shell’s total divi-dends for each of the next ﬁve years. In Year þ6, total dividends are projected for Shell assumingthat its income statement and balance sheet will grow at a long-term growth rate of 3%.Year þ1 Year þ2 Year þ3 Year þ4 Year þ5 Year þ6Projected growth 5% 5% 5% 5% 5% 3%Projected total dividendsto common equity $13,743 $14,431 $15,152 $15,910 $16,705 $17,206At the end of Year 0, Shell had a market beta of 0.71. At that time, yields on intermediate-term U.S.Treasuries were 3.5%. Assume that the market required a 5.0% risk premium. Suppose Shell had6,241 million shares outstanding at the beginning of Year þ 1 that traded at a share price of $24.87. REQUIREDREQUIRED a. Calculate the required rate of return on equity for Shell as of the beginning of Year þ1. b. Calculate the sum of the present value of total dividends for Years þ1 through þ5. c. Calculate the continuing value of Shell at the start of Year þ6 using the perpetuity-with-growth model with Year þ6 total dividends. Also compute the present value of continu-ing value as of the beginning of Year þ1. d. Compute the total present value of dividends for Shell as of the beginning of Year þ1.Remember to adjust the present value for midyear discounting. e. Compute the value per share of Shell as of the beginning of Year þ1. f. Given the share price at the start of Year þ1, do Shell shares appear underpriced, over-priced, or correctly priced Problems and Cases 12.12 12.12 Valuing a Leveraged Buyout Candidate. May Department StoresCompany (May) operates retail department store chains throughout the United States. Assumethat at the end of Year 2, May’s balanc e sheet reports debt of $4,658 million and commonshareholders’ equity at book value of $3,923 million. The market value of its common stock is$6,705, and its market equity beta is 0.88.Suppose an equity buyout group is consideri ng an LBO of May as of the beginning of Year 3.The group intends to ﬁnance the buyout with 25% common equity and 75% debt carrying aninterest rate of 10%. Assume the group projects that the free cash ﬂows to all debt and equitycapital stakeholders of May will be as follows: Year 3, $798 million; Year 4, $861 million; Year 5,$904 million; Year 6, $850 million; Year 7, $834 million; Year 8, $884 million; Year 9, $919 mil-lion; Year 10, $947 million; Year 11, $985 million ; and Year 12, $1,034 million. The group projectsfree cash ﬂows to grow 3% annually after Year 12.This problem sets forth the steps you might follow in deciding whether to acquire May andthe value to place on the ﬁrm. REQUIREDREQUIRED a. Compute the unlevered market equity (asset) beta of May before consideration of theLBO. Assume that the book value of the debt equals its market value. The income tax rateis 35%. (See Chapter 11.) b. Compute the cost of equity capital with the new capital structure that results from theLBO. Assume a risk-free rate of 4.2% and a market risk premium of 5.0%. c. Compute the weighted-average cost of capital of the new capital structure. d. Compute the present value of the projected free cash ﬂows to all debt and equity capitalstakeholders at the weighted-average cost of capital. Ignore the midyear adjustmentrelated to the assumption that cash ﬂows occur, on average, over the year. In computingthe continuing value, apply the projected growth rate in free cash ﬂows after Year 12 of3% directly to the free cash ﬂows of Year 12. e. Assu me that the buyout grou p acquires May for the value determined in Requirement d. Assuming that the realized free cash ﬂows coincide with projections, will May generatesufﬁcient cash ﬂow each year to service the interest on the debt? Explain.