Using the Market-Derived Model

Using the Market-Derived Model

Problem 1 (6 Points)

Using the Market-Derived Model discussed in class, please estimate the cost of equity capital for Allstate (Ticker: ALL) as of December 3, 2021.

 Note that on Friday, December 3, the closing price of Allstate Common stock was $ 108.32.   Assume that Call Options that expire in January 2024 with an exercise price of $ 110.00 had a closing price of $ 13.00.   Further, please indicate any assumptions that you are making regarding the risk-free rate, the expected return on AllState bonds, and the firm’s dividend policy.

Problem 2 (5 Points)

 Some excerpts from the most recent Allstate annual report are provided below. 

The first excerpt contains information related to (insurance) premiums for various Allstate lines of insurance:

 The second excerpt contains information related to the “renewal rates” of Allstate’s Automobile Insurance policies:



The third exhibit contain information related to Allstate’s expenses.  “Loss Ratio”, is calculated as insurance claims divided by insurance premiums, and is provided below.  The “Expense ratio” is calculated as “administrative expense” divided by “premiums”.    The “Combined Ratio” is the sum of the Loss Ratio and the Expense Ratio.  





  Suppose that on January 1, 2021, you were interested in the operating value of the “Auto” 

line of insurance for their existing customers. What is your estimated value for this line of business?

 You may assume that in the future, the “Loss Ratio”, “Expense Ratio”, and “Renewal Ratio” will be equal to the three year average of these numbers.  (Ignore the “Shelter in Place Payback Expense”)   You may assume that the average premium will increase by 3.0% per year, that Allstate pays taxes at a rate of 20%, and that Allstate has a cost of capital equal to your answer from Problem 1 (assume 12% if you didn’t solve problem one). Please indicate any other assumptions that you are making.

Problem 3 (4 Points)

As discussed in class, it has been suggested that Helen of Troy, Ltd. is somewhat “aggressive” regarding the capitalization of certain costs.  In particular, Helen of Troy indicates that “General and administrative expenses in inventory include all the expenses of operating the company’s sourcing activities, expenses incurred for production monitoring, and expenses incurred for product design, engineering and packaging”.  

Suppose that Helen of Troy had always expensed these costs, rather than initially capitalizing and subsequently expensing them. Assuming that bonus structure for Helen of Troy’s CEO was not impacted by this assumption, the CEO’s bonus for the year-ending February 28, 2011 would have been:
$ ______ HIGHER / LOWER than the actual bonus

    that was paid to the CEO based on their actual accounting policies.  

You may find Helen of Troy’s Annual Report, Proxy Statement, and other SEC filings in the Investor Relations section of their website:

http://www.hotus.com

Sample Solution