14. (1) According to http://finance.yahoo.com, “Key Statistics”, what are the given values of CAT’s “Market Cap (for equity)” E and “Total Debt” D, respectively? And thus what shall be CAT’s “weight of equity capital, We” and “weight of debt capital, Wd”, respectively?
Hints: For example, if a firm’s reported “Market Cap” is $75 billion, “Total Debt” is $25 billion, then We = 75 bil / (75 bil + 25 bil) = 75 bil / 100 bil = 0.75 (or 75%), and Wd = 25 bil / (75 bil + 25 bil) = 25 bil / 100 bil = 0.25 (or 25%).
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/histretSP.html In prior Ch. 12 HW Part B, we find from online data source that the long-term average expected return for US stock market (Rm) was xx.xx% per year, while the long-term average expected return for US “risk-free” T-bill (Rf) was xx.xx% per year. Furthermore, via Money MSN, under CAT’s “Quote”==>””Financial Highlights” (just below where you found CAT’s “dividend rate” amount in Ch. 08 HW), we can find CAT’s systematic risk “Beta” value is given as x.xx.
(1) Use those given data from web sources, plug them into the CAPM formula E(Ri) = Rf + BETAi * [E(Rm) – Rf], and calculate “what is E(Ri), i.e., the fair expected or required return for CAT stock in market equilibrium?”
(2) Remember in Ch. 08 HW, how did we use “dividend growth model”, P0 = D0 * (1 + g) / (R – g), to calculate CAT’s fair price in market equilibrium? Well, back then the required return R is given subjectively as either “11.26%” or “1.63%” (just as a matter of wild guessing). Now, after studying Ch. 13, we know how to objectively estimate the expected or required return as a matter of fact, e.g., by using the market-data-based CAPM calculation answer for E(Ri).
Use your calculated E(Ri) from the aforementioned HW step (1), plug it as R into the dividend growth model formula, and recalculate “what is P0, i.e., the fair price for CAT stock in market equilibrium?”
Part B, Web-based Exercises:
Please note: “cost of capital” is the same as “required return (i.e., expected return)” of capital, and “security market line” SML is the same as CAPM.)