HW #5: For Thursday, Oct 1st

1. Read Chapter 3, Cost Estimation Techniques, from the course textbook. All of this material is
possible subject matter of the upcoming midterm exam on Oct 6th.
2. Answer Questions 3-13, 3-20, 3-22 and 3-34 found at the end of Chapter 3. In Question 3-20,
estimate the combined total cost of material and manufacturing for the 100 prefabricated
structures in 2014. Note, also, that the manufacturing cost for the first 1,000 SF structure is
$12,000 in 2014. Solve Question 3-22 using the manual linear regression equations described
in Chapter 3. Be sure to show all your work. In Question 3-22 part (b) also find the Standard
Error and comment on the goodness of fit. Finally, check your results in Question 3-22 using
Excels linear regression package. Be sure to attach a copy of your Excel linear regression
results. Provide a graph showing your raw data points and the line produced by your CER. In
Question 3-34 also comment on the problem(s) associated with using the bottom-up pricing
approach described in the question.
3. NOTE: The following part of todays assignment requires knowledge of the Capital Asset
Pricing Model (CAPM) which will be covered in class on Tuesday, Sept 29th. Allison will also
be prepared to explain this methodology in her office hours on Tuesday evening. It is not
included in the course textbook. This material is possible subject matter of the upcoming
midterm exam on Oct 6th.
Answer the following questions:
A semiconductor company has an equity beta of 1.6, a debt-to-equity ratio of 0.06, an average
cost of debt of 6.0% p.a., and an effective income tax rate of 10%. The current rate on longterm U.S. government Treasury Bills is 3.0% p.a. The market risk premium (RM-RF) pertaining
to a diversified portfolio of corporate common stock is about 8% p.a. Estimate this companys:
(a) cost of equity; and (b) its weighted average cost of capital. If the company were to increase
its debt-to-equity ratio from 0.06 to 0.12, how would these two values change (assuming the
increased leverage does not affect the companys average cost of debt)? Meanwhile, an electric
utility company has an equity beta of 0.75, a debt-to-equity ratio of 0.8, an average cost of debt
of 4.5% p.a., and an effective income tax rate of 25%. What is the utility companys: (a) cost of
equity; and (b) weighted average cost of capital? Then, explain in 1-page typed essay format
why there are differences between these two companies with respect to their beta values, debtto-equity ratios, and average cost of debt.
Write up your answers, showing all work, neatly and concisely on 8.5 x 11 inch paper. Be sure
your name appears at the top of each page and staple multiple pages together. Submit your
answers at the beginning of class. Late submittals will not be accepted. All work is to be your
own, consistent with the University Honor Councils Guide to Academic Integrity.
4. READING AHEAD. If you wish to read ahead to familiarize yourself with material to be
covered in class after the upcoming exam, read Chapter 7 Depreciation and Income Taxes
in the textbook.