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Great Dane, a Danish firm, has systematic risk of 0.9 when measured against the MSCI World Market Index. Its systematic risk is 1.25 when measured against the Danish stock index. The expected returns on the MSCI world index and the Danish index are 9% and 13% respectively. The annual risk free rate in the Denmark is 5% and Great Dane's corporate tax rate is 43%. Consider the following two scenarios about the Danish capital market: Scenario

1: The Danish market is integrated with the rest of the world. Under this scenario Great Dane can borrow in the Eurobond market at 5.5% and international investors are willing to tolerate a 70% debt-to-equity ratio at this cost of debt. Scenario

2: The Danish market is segmented from the rest of the world Under this scenario Great Dane can borrow in Denmark at a 6.6% interest rate and maintain a debt-to-equity ratio of 2/3. a. What is the required rate of return on the Great Dane's stock under scenario #1 and scenario #2? b. What is Great Dane's weighted average cost of capital under scenario #1 and scenario #2? c. Suppose that Great Dane is expected to generate before-tax operating cash flow of 700 million Danisk Krona (DK) at the end the next year. This cash flow is expected to grow at 4% perpetually. What is the value of Great Dane under scenario #1 and scenario #2 ?

Macroeconomics, Economics

  • Category:- Macroeconomics
  • Reference No.:- M9686404

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