Risk and Return in Practice: Problems and Questions

1. In December 1995, Boise Cascade's stock had a beta of 0.95. The treasury bill rate at the time was 5.8%, and the treasury bond rate was 6.4%. The firm had debt outstanding of $ 1.7 billion and a market value of equity of $ 1.5 billion; the corporate marginal tax rate was 36%.

2. Boise Cascade also had debt outstanding of $ 1.7 billion and a market value of equity of $ 1.5 billion; the corporate marginal tax rate was 36%.

3. Biogen Inc., as biotechnology firm, had a beta of 1.70 in 1995. It had no debt outstanding at the end of that year.

4. Genting Berhad is a Malaysian conglomerate, with holding in plantations and tourist resorts. The beta estimated for the firm, relative to the Malaysian stock exchange, is 1.15, and the long term government borrowing rate in Malaysia is 11.5%.

5. You have just done a regression of monthly stock returns of HeavyTech Inc., a manufacturer of heavy machinery, on monthly market returns over the last five years and come up with the following regression:

RHeavyTech = 0.5% + 1.2 RM

The variance of the stock is 50% and the variance of the market is 20%. The current T.Bill rate is 3% (It was 5% one year ago). The stock is currently selling for $50, down $4 over the last year, and has paid a dividend of $2 during the last year and expects to pay a dividend of $2.50 over the next year. The NYSE composite has gone down 8% over the last year, with a dividend yield of 3%. HeavyTech Inc. has a tax rate of 40%.

6. Safecorp, which owns and operates grocery stores across the United States, currently has $50 million in debt and $100 million in equity outstanding. Its stock has a beta of 1.2. It is planning a leveraged buyout , where it will increase its debt/equity ratio of 8. If the tax rate is 40%, what will the beta of the equity in the firm be after the LBO?

7. Novell, which had a market value of equity of $2 billion and a beta of 1.50, announced that it was acquiring WordPerfect, which had a market value of equity of $ 1 billion, and a beta of 1.30. Neither firm had any debt in its financial structure at the time of the acquisition, and the corporate tax rate was 40%.

8. You are analyzing the beta for Hewlett Packard and have broken down the company into four broad business groups, with market values and betas for each group.
Business Group Market Value of Equity Beta
Mainframes $ 2.0 billion 1.10
Personal Computers $ 2.0 billion 1.50
Software $ 1.0 billion 2.00
Printers $ 3.0 billion 1.00

9. The following table summarizes the percentage changes in operating income, percentage changes in revenue and betas for four pharmaceutical firms.
Firm % Change in Revenue % Change in Operating Income Beta
PharmaCorp 27% 25% 1.00
SynerCorp 25% 32% 1.15
BioMed 23% 36% 1.30
Safemed 21% 40% 1.40

10. A prominent beta estimation service reports the beta of Comcast Corporation, a major cable TV operator, to be 1.45. The service claims to use weekly returns on the stock over the prior five years and the NYSE composite as the market index to estimate betas. You replicate the regression using weekly returns over the same period and arrive at a beta estimate of 1.60. How would you reconcile the two estimates?

11. Battle Mountain is a mining company, which mines gold, silver and copper in mines in South America, Africa and Australia. The beta for the stock is estimated to be 0.30. Given the volatility in commodity prices, how would you explain the low beta?

12. You have collected returns on AnaDone Corporation (AD Corp.), a large diversified manufacturing firm, and the NYSE index for five years:
Year AD Corp NYSE
1981 10% 5%
1982 5% 15%
1983 -5% 8%
1984 20% 12%
1985 -5% -5%

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 20 million shares outstanding, and the current market price is $ 2. The firm has $ 20 million in debt outstanding. (The firm has a tax rate of 36%)

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.

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 ñ

Rstock = 3.28% + 1.65 RMarket R2= 0.20

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.

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 ñ

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 ñ

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%.

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%.

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.

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%.

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 of comparable firms is 1.20; the average debt/equity ratio for these firms is 50%. The marginal corporate tax rate is 36%.

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 ñ

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.