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| Topic: |
Business
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| Number of pages / Number of words: |
4 / 988 |
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The optimal decision was to use APV approach.
The first step was to calculate R0. As the asset beta is not given, we used CAPM to calculate the equity cost of capital.
To calculate the equity beta, we used an arithmetic average of the historical betas (from 1982 to 1987). Because beta is a very volatile quantity, the beta of 1987 may not fully represent the real equity beta of RJR Nabisco...
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Because beta is a very volatile quantity, the beta of 1987 may not fully represent the real equity beta of RJR Nabisco. We obtained ?S=0.89. The risk-free rate and the market premium are assumed to be 9% and 8%, respectively, so we obtained an equity cost of capital of (RS) of 16.15%. To obtain R0, we solved the equation in MM II Proposition:
Note that we want to calculate the value of RJR Nabisco for the year of 1987, so we used exhibit 3 to get the debt-equity ratio in 1987 and exhibit 2 to calculate the value of taxes paid in the same year...
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General points of the essay
Capital Asset Pricing Model (CAPM)vs.Arbitrage Pricing Theory (APT).
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