Answer Happy

Question 3 (25 marks) a) GemStone Pte Ltd earns a return on invested capital of 20% on its existing stores. Given intense competition for new store sites, you believe new stores will earn only their cost of capital. Consequently, you set return on new invested capital (RONIC) (8%) equal to the cost of capital (8%) in the continuing-value formula. A colleague argues that this is too conservative, as GemStone Pte Ltd will create value well beyond the forecast period. What is the flaw in your colleague's argument? (5 marks) b) When making forecasts and analysing the results of a firm, increasing one variable usually means decreasing another. List three of the several possible common trade-offs that should be considered in making such forecasts/analysis. (9 marks) c) An analyst gathers the following information for Firm A and Firm B operating in the same industry. Use the information to compute the industry unlevered beta and the appropriate beta for each company for use in the WACC. Assume that the debt beta (Ba) for both firms is zero. Firm A: CAPM beta=0.85; debt-to-equity ratio = 0.4 Firm B: CAPM beta = 1.2; debt-to-equity ratio = 2 (11 marks) D be = 6, +(6,- bd) E b+ )