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Bama Gambler
03-04-2002, 01:09 PM
#1 pg 161 Exercise 1:
A firm's cost of capital is 11%, and its beta is 1.1. If the risk-free rate is 4%, what is the market rate of return?

r = 11, B = 1.1, rf = 4
11 – 4 = 1.1 (rm – 4)
rm = 10.36 (Solution claims 14)

#2
pg 161 Exercise 3:
A firm is financed 70% with equity and 30% with debt. The cost of debt is 7%, the beta of debt is .5. The cost of equity is 16%. The risk-free rate is 4%. Find: beta of equity, beta of firm, cost of capital for the firm, and the certainty equivalent of a $1,000 cash flow for the firm.

The solution uses r (cost of capital) to find the certainty equivalent, but the formula for certainty equivalent (given on pg 159) uses rE (cost of firm’s equity).

How-to-pass solution: CE = $917.91
My solution: CE = $896.55

Are these errors?
Bama Gambler


<font size=-1>[ This Message was edited by: Bama Gambler on 2002-03-04 13:10 ]</font>
bg23516
03-04-2002, 03:24 PM
Without my text around, I don't remember how to do the second one offhand. The first one, however, I believe you are right on.
Drzy
03-04-2002, 10:46 PM
Without actually working yours out (I'm feeling lazy), I can tell you that I'm using this manual and it is majorly chock full of errors. Otherwise it's an awesome guide.... I wonder if they publish an errata list or something.
Bama Gambler
03-05-2002, 10:54 AM
I tried to email the auther at gordon@how-to-pass.com but I get the following error:

Sorry, unable to deliver your message to gordon@how-to-pass.com for the following reason:

552 Quota violation for gordon@how-to-pass.com

Bama Gambler
Drzy
03-05-2002, 11:56 AM
He's on the University of Iowa actuarial teaching staff now. Here's his school e-mail:
gordon-e-klein@uiowa.edu
glenn
03-05-2002, 12:10 PM
I get the error message when I email the how-to-pass address, but he does get the the email nevertheless.
Bama Gambler
03-05-2002, 12:31 PM
how do you know he gets the email?
glenn
03-05-2002, 12:56 PM
I've sent him email to this address, received the error message, but he's still replied to my email.
ookawasan
03-05-2002, 10:15 PM
Bama Gambler:

I did those problems and got what the study guide solutions have. I do think that you need to use the real cost of equity to solve for the certainty equivalent, because it is cash flows that we are dealing with. Cash flows in this case implicitly assume that it is a mixture of debt and equity. That's how I interpret it anyway.
ookawasan
03-05-2002, 10:17 PM
Bama Gambler:

One little clarification:

I do think that the study guide solution to the first problem is wrong. I also got 10.36%.
Bama Gambler
04-02-2002, 12:19 PM
just received reply from gordon. my solutions are correct for both problems.

Bama Gambler
Bama Gambler
04-02-2002, 12:20 PM
just received reply from gordon. my solutions are correct for both problems.

Bama Gambler