Case# 01.

Assume newly formed Corporation ABC needs to raise $1 million in capital so it

can buy office buildings and the equipment needed to conduct its business. The
company issues and sells 6,000 shares of stock at $100 each to raise the first
$600,000. Because shareholders expect a return of 6% on their investment, the cost
of equity is 6%.

Corporation ABC then sells 400 bonds for $1,000 each to raise the other $400,000
in capital. The people who bought those bonds expect a 5% return, so ABC's cost
of debt is 5%.

WACC = ((E/V) * Re) + [((D/V) * Rd)

E = Market value of the company's equity

D = Market value of the company's debt
V = Total Market Value of the company (E + D)
Re = Cost of Equity
Rd = Cost of Debt

WACC = (($600,000/$1,000,000) x .06) + [(($400,000/$1,000,000) x .05)

= .036+.02
= .056

=5.6%

Corporation ABC's weighted average cost of capital is 5.6%

Case# 02.

An investment in an asset that has an annual appreciation of

10%, 5%, and -2% over three years. As stated in the prior section,
simply adding the annual appreciation of each year together
would be inaccurate as the 5% earned in year two would be on
the original value plus the 10% earned in the first year. After
putting the annual percentage into the holding period return
formula.

Y R

1 10% =(1+r1)*(1+r2)*(1+r3)-1

2 5% =(1.10)*(1.05)*(.98)-1

3 -2% =.1319%

Geo. mean ave.

=3root(1+r1)*(1+r2)*(1+r3)-1
Case# 03.

a model might state that an investment has a 10% chance of a

100% return and a 90% chance of a 50% return. The expected
return is calculated as:

The return on an investment as estimated by an asset pricing

model. It is calculated by taking the average of the probability
distribution of all possible returns.

Expected Return = 0.1(1) + 0.9(0.5)

= 0.55

= 55%.
Case# 04.

Modigliani and Miller approach:

Modigliani and Miller concur with net operate income (NOI) and
provide a behavieour justification for the irrelevance of capital
structure. They maintain the cost of capital and the value of the
firm do not change with a change in leverage.

Differences between Modigliani and Miller. Proposition 1 and

Modigliani and Miller. Proposition 2:

Proposition 1:

The overall cost of capital (Ko) and the value of the firm (V) are
independent of its capital structure. The ko and v are constrant
for all degree of leverage. The total value is given by capitalizing
the expected stream of operating earning at a discount rate,
appropriate for its risk class.

Proposition 2:

The second Proposition MMS tells that the ke is equal to the

capitalization rate of a pure equity stream plus a premium for
financial risk equal to the difference between the pure equity_
capitalization