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Luther Industries has 25 million shares outstanding trading at $18 per share. In addition, Luther has $150 million in outstanding debt. Suppose S&P 500 index has a rate of return at 16% and the Treasury bill has a rate of return 4%. Beta coefficient of Luther's equity stock is 0.3. Luther's debt cost of capital is 7%, and the corporate tax rate is 30%. Standard deviation of Luther's stock return is 3.
Problem (1) Calculate Luther's weighted average cost of capital (WACC)
Problem (2) Luther Industries is a growing company. The Free Cash Flow of the company is $450 million at the end of this year and maintains a constant growth rate at 4% from next year. Calculate the firm value based on the cost of capital you estimated in WACC .
Problem (3) Now you invest in a portfolio with the beta of 0.15 and the standard deviation of 1.5. You plan to use 50% of your current investment in the portfolio to buy Luther's stocks. Given that the correlation coefficient between Luther's stocks and your portfolio is -1. Compare risk-return situation of your current portfolio with the one of the portfolio including Luther's stocks and determine whether to buy Luther's stocks or not?
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