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Your company announces that it will pay out a constant annual dividend of $2.00 per share for the next ten years. Following that, the dividend will grow at 4 percent per year and will be paid out in perpetuity at this growth rate (for example, the dividend at t=11 will be $2.00 x 1.04 = $2.08 per share). The company has an equity beta of 1.25. Assume a risk-free rate of 2.5 percent and a market risk premium of 6 percent. a) Based on the information provided above, what is the correct price per share for your company today? b) You would like to calculate the beta of your company’s assets, in order to get an idea of the sensitivity of your business operations to market conditions. Your company currently has 5M common shares outstanding, and 50K bonds outstanding priced at $900 per bond. These bonds are fairly low risk, so you think a beta of 0.05 is a reasonable assumption for these bonds. Given this information and your calculation in part (a), what is the beta of your company’s assets? c) Following this calculation, you realize that $35M of your company’s assets consist of riskless U.S. Treasury bonds, with the remainder consisting of the company’s operating assets. What is the beta of your company’s operating assets? Hint: use the formula provided in Question 2(b), with one “division” being the Treasury bond holdings and the other “division” being the operating assets. Also keep in mind that the value of the company’s assets equals the value of the company’s operating assets plus the value of the Treasury bonds held by the company.
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