March 2021 | MGMT 332 | College of Business |worldwide.erau.eduAll rights are reserved. The material contained herein is the copyright property of Embry-Riddle Aeronautical University, Daytona Beach, Florida, 32114. No part of this material may be reproduced, stored in a retrieval system or transmitted in any form, electronic, mechanical, photocopying, recording or otherwise without the prior written consent of the University.MGMT 332 Corporate Finance IModule 6: Return, Risk, and the Cost of CapitalProblem Set 6 – Return, Risk, and the Cost of Capital1. Argo Airlines is looking to buy Aerial Airlines. Your boss, the CFO, wants a quick and dirty valuation of Aerial. You choose to look at past transactions in the airline industry to get some numbers. You find the following from reported transactions for the average price paid:a. 17x the acquired firm’s earnings per share (EPS) b. 5.5x EBITDA c. 33.0% premium of share priceFor Aerial, you find out the following: a. EPS = $3.00 b. EBITDA = $755 million (debt value = $1,100 million) c. Stock Price = $41.25 (65 million shares outstanding)Using EPS, EBITDA, and premium over stock price, what should be Aerial’s prices per share? What is the average of the three?2. You have been asked to calculate the cost of equity for three firms – Eastern, Western, and Northern. You know the following:Firm Beta Cost of Debt Debt/AssetsEastern 1.80 3.3% 37% Western 1.45 3.8% 69% Northern 1.20 2.9% 40%You know the following:• 10-year Treasury yield = 1.10% • Market Premium = 5.5% • Average Tax Rate = 21%What are the expected returns on equity and WACCs for each of these firms?CONTINUES ON THE NEXT PAGEhttp://www.worldwide.erau.edu/Page 2 of 23. You have been asked to calculate the dividend discount model-based price per share for the three airlines shown above. You know the following for 2019:Firm Dividend Growth/yearEastern 3.05 3.1% Western 2.00 2.0% Northern 2.20 2.7%You already know their WACCs, so you can use them to present value the stream of dividends. Remember that the terminal value uses the perpetuity formula and that it automatically shows the value as of the beginning of the year when it is calculated!Module 6: Return, Risk, and the Cost of Capital
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