12. Microsoft\'s beta is 0.9 and Amazon\'s beta is 1.5. Microsoft\'s market valu
ID: 2819183 • Letter: 1
Question
12. Microsoft's beta is 0.9 and Amazon's beta is 1.5. Microsoft's market value of equity is 500 billion and Amazon's market value of equity is 1 trillion. What is the beta of an equally weighted portfolio of Microsoft and Amazon stocks? What is the beta of a value-weighted portfolio of the two firms? 13. Nike has a project that will produce cash flows $200 next year if the economy is strong and $50 if the economy is weak. Suppose the corporate tax rate is 0. This project requires upfront costs of $70. The economy will be strong with probability 50%. Nike raised $60 by issuing debt and $50 by issuing equity. Nike promised $20 as the interest payments. So, the creditors will receive $80 in total if the economy is strong and $50 if the economy is bad, because of limited liability The market risk premium is 7% and the risk-free rate is 5%. The entrepreneur of Nike has no equity shares in her firm. (a) What's the expected return required by the creditors? What's the debt beta? (b) What are the residual payoffs to the equity holders? (c) What's the expected return required by the equity investors? What's the equity beta? (d) What's the cost of capital of Nike? (e) What's the levered asset beta of Nike? Here, the levered asset beta means the beta for the portfolio of an investor who holds all the bonds and equities issued by Nike (f) Imagine that Nike issues only equity instead of issuing both equity and bonds. What's the cost of capital for this case? What's the unlevered beta of Nike? (g) How much did the entrepreneur of Nike earn as the profits? (h) Suppose the upfront investment costs increase to $80. All other things remain the same. Does this change affect the cost of debt and cost of equity? Explain your answer Now, suppose there is another shoes company, New Balance. This firm also has a project that will produce $200 next year if the economy is strong and $50 if the economy is weak. This project requires upfront costs of $70. The entrepreneur of New Balance does not have enough finance knowledge. She is also very conservative. So, she wants to raise only $40 by issuing debt. Then, because 40 × 1.05 = 42Explanation / Answer
Q 12.
Beta measures the risk or volatility of an equity relative to the market portfolio( typically S&P 500). It measures of the movement of the particular equity with respect to market as a whole.
THe value of Beta varies between -ve to +ve. Where +ve value denotes positive correlation between the return of the equity with the market. -ve value denotes the opposite movement of the equity with respect to the market movement, if the market moves up the equity will move down and vice versa.
If the Beta is 0, it denotes perfect detachment of the equity movement with respect to market.
Combined Beta of two asset portfolio can be found by calculating the weighted average of the Betas of assets included in the portfolio. The weights can be relative share of equity in the portfolio.
Beta of equally weighted portfolio
the weight of Microsoft equity=.5 , the weight of Amazon equity=.5 ,
Beta of the portfolio = .5 x 0.9 + 0.5 x 1.5 = 1.2
Beta of value weighted portfolio
Let the value of portfolio= 1500
the weight of Microsoft equity=500/1500=1/3 , the weight of Amazon equity=1000/1500 = 2/3 ,
Beta of the portfolio = 1/3 x 0.9 + 2/3 x 1.5 = 1.3
Question 13 can not be answered as per the Chegg policy (one question per query please).
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