Airthread Case Analysis

Homework 2

Calculating the Cost of Capital

Due Wed Jan 27th 2015

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The next step to value the company you chose in HW#1 is to compute the equity beta, and the equity cost of capital. As you learnt in class, there are three ways to compute the equity beta: (1) running a regression using a single factor model; (2) use comparable companies; (3) running a regression using a multi-factor model. In this homework assignment, you will have to use all three methods, and compare the results.

1. Regression Analysis

You will calculate the cost of equity capital (re) for your company running a regression analysis following the CAPM. You plan to follow a relatively standard procedure. Specifically, you plan to:

1. Pull a reasonable number of years of weekly price data from Yahoo! Finance (use the “Adjusted Close” price which captures dividends and any stock splits. Make sure that you state in the write-up how long of a time series you used, and why;  [select “Historical Prices”, select the appropriate start and end dates, and select “Weekly prices”; when you get the price series, download the data as a spreadsheet;]
2. Calculate weekly returns from your price data using the “Adjusted Close” price. [return for period t is defined as the ratio (pt-pt-1)/pt-1, where pt is the price of the stock at time t]
3. Repeat a) and b) for the S&P 500 Composite Index (use the symbol “^GSPC” in Yahoo! Finance.);
4. Calculate the equity beta using the stock’s return data and corresponding return data on the S&P 500 Index [using Excel, go to “data” menu, choose “data analysis” (this is an add-in, so you may have to install it http://office.microsoft.com/en-us/excel-help/load-the-analysis-toolpak-HP010021569.aspx ),  and from the list pick “regression”; your Y variable is stock returns, and the X variable market returns. Your estimate for beta will be the coefficient on the X variable] 
5. Use the beta in the CAPM to calculate a estimate of your firm’s cost of equity.  Use an appropriate risk-free rate and  Market Risk Premium (Daily data on US treasury bond rates can be found  on the US Treasury Website at http://www.ustreas.gov/offices/domestic-finance/debt-management/interest-rate/yield.shtml

1. Comparable Companies

First, you will choose between 3 and 5 public companies who you think are comparable with your company. Choose reasonable comparables in terms of size, industry, and life-cycle. Fill up the table below assigning weights from 0 to 10 for each comparable company, for each similarity dimension. This table will give you a simple way to quantify how similar comparable companies are to your company.