Find the cost of equity for GE and Alstom. For market rate, use S&P 500 index re

Question

Find the cost of equity for GE and Alstom. For market rate, use S&P 500 index return.

a) Find the beta of GE (GE) and Alstom (ALSO.PA) from Reuters. Which one is riskier? Are they

riskier then the market? Why? Why not?

b) For risk free rate, use 10 year US Treausry rate, which is 2.5%.

c) Find 2013 S&P 500 index return from http://www.1stock1.com/1stock1_141.htm and use it

as the market rate of return in below question.

d) Using cost of equity formula in Chapter 10, find the cost of equity for GE and Alstom. Are

they different? Which one has higher cost of equity? Why?

Find the cost of debt for GE and Alstom.

a) GE has a credit rating of AA+ and Alstom has a credit rating of BBB. Which one is riskier?

Why?

b) Default risk premium on AA+ rated bonds are 3% and BBB rated bonds are 6%. The

marginal tax rate for both companies is 30%. What is the after tax cost of debt for GE and Alstom if the risk free rate (10 year US Treasury rate) is 2.5% ?

Suppose both GE and Alstom have 60% debt and 40% equity in their capital structure. They do not have any preferred stock. What is the WACC of GE and Alstom? Which one has a higher WACC? Why?

Suppose both GE and Alstom have a major project that they are considering. What should be the minimum return on the project, so that they will take on the project?

Explanation / Answer

a) Beta of GE = 1.28, Beta of Alstom = 1.25

On the basis of beta GE is more riskier than the Alstom because its beta is higher than the Alstom. Higher beta means high variation in returns.

Both the stock is riskier than the market because beta of both the stock is higher than the market beta which is 1.

c) S&P 500 index return for 2013 = 29.60%

d) Cost of Capital according to CAPM = rf + Beta(rm - rf)

FOR GE:

rf = Risk Free return = 2.5%, Beta of GE = 1.28 rm = Market Return = 29.60%

Cost of Equity = 2.5 + 1.28(29.60 - 2.5) = 37.19%

FOR Alstom:

rf = Risk Free return = 2.5%, Beta of GE = 1.25 rm = Market Return = 29.60%

Cost of Equity = 2.5 + 1.25(29.60 - 2.5) = 36.38%

Related Questions

Navigate

• Browse (All)
• Browse F
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.