Question:
You are given the following information for Golden Fleece Financial:
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Long-term debt outstanding:
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$300,000
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Current yield to maturity (r debt):
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8%
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Number of shares of common stock:
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10,000
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Price per share:
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$50
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Book value per share:
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$25
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Expected rate of return on stock (r equity):
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15%
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1. Calculate Golden Fleece's company cost of capital. Ignore taxes.
2. Look again at Table 9.1 . This time we will concentrate on Burlington Northern.
a. Calculate Burlington's cost of equity from the CAPM using its own beta estimate and the industry beta estimate. How different are your answers? Assume a risk-free rate of 5% and a market risk premium of 7%.
b. Can you be confident that Burlington's true beta is not the industry average?
c. Under what circumstances might you advise Burlington to calculate its cost of equity based on its own beta estimate?