Questions

SP2025.B62.FIN.534 Quiz 3 (Lecture 3)

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Prokter and Gramble (PKGR) has historically maintained, and currently has, a debt-equity ratio of 0.25. Its current stock price is $56 per share, with 2.4 billion shares outstanding. The firm enjoys very stable demand for its products, and consequently, it has a low equity beta of 0.5 and can borrow at 4.25%, just 25 basis points over the risk-free rate of 4%. The market risk premium is 6%, and PKGR’s tax rate is 20%. What is PKGR’s equity cost of capital? [ Select ] 10% 7% 6% What is PKGR’s WACC? [ Select ] 4.1% 5.5% 6.3% 4.3% This year, PKGR is expected to have free cash flows of $5 billion. What constant expected growth rate of free cash flow is consistent with its current stock price? [ Select ] 2.9% 4.1% 3.3% 2.7%

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We begin by restating the problem to ensure we are evaluating the right data and questions. PKGR has a debt–equity ratio of 0.25, a current stock price of $56, 2.4 billion shares outstanding, a low equity beta of 0.5, and can borrow at 4.25% (25 basis points over a risk-free rate of 4%). The market risk premium is 6%, and the corporate tax rate is 20%. We are asked for: (1) equity cost of capital, (2) WACC, and (3) the growth rate g in a perpetual FCF model that yields the current stock price. Now, analyze each option for the equity cost of capital. Option A: 10% This would require a cost of equity that is much higher than the given beta of 0.5 and the market premium of 6%. Using the CAPM framework, ke = rf + beta × (market premium) = 4% + 0.5 × 6% = 7%. An 10% cost is inconsistent with the provided beta and risk premium, suggesting an incorrect interpretation ......Login to view full explanation

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