Corporate Finance, Fall 03

Exam #2 review questions (full solutions at end of document)

1. Portfolio risk & return.
da!o "lopes (") and #a$ota "teppes (#") are %ot! seasonal %usinesses& " is a down!ill s$iin' facilit(,
w!ile #" is a tour compan( t!at speciali)es in wal$in' tours and campin'& *!e returns on eac! compan(
over t!e next (ear is expected to %e+
Econom( da!o "lopes #a$ota "teppes
"tron' #ownturn ,-0. 2.
/ild #ownturn ,0. 1.
"low 2rowt! 0. 3.
/oderate 2rowt! -2. 0.
"tron' 2rowt! 20. 0.
a) Find t!e mean and variance of returns for eac! compan(&
%) Find t!e covariance and correlation of returns for t!e two companies&
c) f " and #" are com%ined in a portfolio wit! 40. invested in eac!, find t!e portfolio expected return
and standard devia tion&
IS = 4.4
DS = 4.6
s
2
s
2
IS
=
0.011584
DS
= 0.000304
s
DS
= .
000056 r
IS,DS
= 0.0298 r
p
=
4.5
s
P
= .
05477
2)
CAPM
5indercare nc& !as a %eta of -&20& *!e ris$ free rate is 3. and t!e expected return on t!e mar$et
portfolio is
-0&4.& *!e compan( presentl( pa(s an annual dividend of 64 per s!are, and investors
expect it to experience a 'rowt! in dividends of -. per annum for man( (ears to come&
a& 7!at is t!e stoc$8s present mar$et price per s!are, assumin' t!e required rate of return is
determined %( t!e C9:/;
%& Consider an alternative investment in t!e stoc$ of /axicare nc& /axicare !as an expected
return of -4.
and a %eta of -&4& "!ould (ou purc!ase t!is stoc$; (w!( or w!(
not;)
a. P =
33.22
b. dont buy
Max!ar".
3)
CAPM
*!e ris$,free rate is 4&4., and t!e mar$et portfolio !as an expected return of -0.& *!e mar$et
portfolio !as a standard deviation of -0.& "toc$ < !as a correlation coefficient wit! t!e mar$et of
0&2 and a standard
deviation of -2.& 9ccordin' to t!e C9:/, w!at is t!e expected rate of return on
stoc$ <;
r
#
=
7.54$
4. Cost of capital
=oo$ Corp& !as 6-00 million face value of outstandin' de%t wit! a coupon of -0. and a (ield to
maturit( of >. (annuali)ed)& *!e %onds ma$e semi,annual pa(ments, and !ave -0 (ears to
matur it(& *!e compan( also !as - million s!ares of common stoc$ wit! %oo$ value per s!are of
634 and a mar$et value per s!are of 640& *!e current %eta of t!e stoc$ is -&4& *!e treasur( ?ill rate
is 4., and t!e mar$et ris$ premium is >&4.& *!e compan( is in t!e 00. tax %rac$et& 7!at is t!e
compan(8s current wei'!ted avera'e cost of capital;
r
%&''
= 8.76$
5. Risk & Return: Estimatin !eta.
@ou wis! to estimate t!e %eta of (our compan( %( loo$in' at compara%le firms& @ou !ave 'at!ered
t!e data on t!e firms indicated %elow& f (ou are currentl( all,equit( financed and face a tax rate of
34., w!at would %e an appropriate estimate for (our %eta;
Firm ?et
a
#
A B -&2 0&
33 @ &
>
0&
24
< -&3 0&
00
b
un(")
= .
907
". Cost of capital
a& Einstein ?a'els is considerin' expandin' into t!e 'ourmet coffee %usiness& *!e coffee %usiness
is expected to %e 20. of t!e overall firm value in -CC>, and t!e avera'e %eta of compara%le coffee
firms is -&30D t!e avera'e de%tAequit( ratio for t!ese firms is 30.& *!e mar'inal corporate tax rate
is 33.& EinsteinEs equit( %eta at t!e end of -CC1 was 0&C0, and t!e compan(Es de%tAequit( ratio was
>0.& f Einstein maintains its current de%t equit( ratio, w!at will its equit( %eta %e in -CC>;
%& 9fter t!e expansion, EinsteinEs cost of de%t will %e --.& f t!e *reasur( %ond rate is 1., and t!e
!istorical mar$et ris$ premium is 4&4., find EinsteinEs wei'!ted avera'e cost of capital&
a. *"+ ,nst"n (")"r"d b"ta = 1
!. #ACC $ 1%.%&'
&. Capital (tructure: Mo)iliani Miller *+eorems
9ssume (ou are in a F/odi'liani /illerG world wit! corporate taxes %ut no costs of financial
distress&
2*E !as perpetual E?* of 6> million per (ear and an all equit( discount rate (r
0
) of -2.& 2*E
!as 6-4 million of de%t outstandin' at a cost >., and its corporate tax rate is 30.&
a) 7!at is 2*E8s value;
%) 7!at is 2*E8s cost of equit(;
a. -
.
= /49.1
b. 0
S
= 13.16$
,. Capital (tructure *+eor-
a& 9ssume (ou are in a /odi'liani /iller world (// propositions and !old)& 9? Corporation
is unlevered and is valued at 6300,000& 9? is currentl( decidin' w!et!er includin' de%t in t!eir
capital structure would increase t!eir value& Hnder consideration is issuin' 6300,000 in new
de%t wit! an >. interest rate& 9? would repurc!ase 6300,000 of stoc$ wit! t!e proceeds of t!e
de%t issue& *!ere are currentl( 32,000 s!ares outstandin' and t!eir effective mar'inal
tax %rac$et is )ero&
(i) 7!at will t!e firm value %e after t!e c!an'e;
(ii) 7!at will t!e s!are price %e and !ow man( s!ares will %e outstandin' after t!e c!an'e;
%& Iow assume (ou are in a /odi'liani /iller world wit! corporate taxes added& C# Corp& is all
equit( financed wit! 4,000 s!ares outstandin' wort! 61 eac!& *!e( are plannin' on issuin'
6-0,000 of new perpetual de%t at t!e >. mar$et rate of interest& *!e effective tax rate is 24.&
7!at is t!e mar$et value of t!e firm8s outstandin' equit( after t!e( ma$e t!e de%t for equit(
exc!an'e;
a.. *"+ 1r2 )a(u"3 /640,000 4MM
Prop I5
a. . *u2b"r o1 s6ar"s outstandn7 = 17,000, S6ar" pr!" = /208s6ar"
b. , = 27,500
C& Capital (tructure.
@ou !ave %een as$ed %( 9? Corporation to evaluate its capital structure& *!e compan( currentl(
!as 20 million s!ares outstandin' tradin' at 620 per s!are& n addition, it !as 6240 million pu%lic
de%t outstandin', rated 99 and wit! a (ield to maturit( of >.& *!e %eta for t!e compan( is -&0, t!e
current *reasur( %ond rate is 3., and t!e mar$et ris$ premium is 4&4.& *!e tax rate is 00.& 9?
Corporation is proposin' to %orrow an additional 6-40 million to use as follows+
- Jepurc!ase 630 million wort! of
stoc$
- :a( 6>0 million in
dividends
- nvest 600 million in a proKect wit! a I:L of 630
million&
*!e additional %orrowin' will cause t!e %ond ratin' to fall to ???, w!ic! currentl( carries a (ield
to maturit( of -0.& =ow will t!e firm8s cost of capital c!an'e wit! t!is additional %orrowin';
(!int+ to simplif( (our calculations, assume t!e total firm value used in computin' 79CC does not
!ave to consider t!e c!an'e in firm value due solel( to t!e c!an'e in total cost of capital)
'urr"nt %&'' = 8.92$
*"+ %&'' = 9.11$
-0& Capital (tructure.
2E Corp& is examinin' its capital structure wit! t!e intent of arrivin' at an optimal de%t ratio& t
currentl( !as no de%t and !as a %eta of -&4& *!e ris$less interest rate is C., and t!e ris$ premium is
>&3.& @our researc! indicates t!at t!e de%t ratin' will as follows at different de%t levels+
#A(#ME) Jatin' nterest rate
0. 999 -0.
-0. 99 -0&4.
20. 9 --.
30. ??? -2.
00. ?? -3.
40. ? -0.
30. CCC -3.
10. CC ->.
>0. C 20.
C0. # 24.
*!e firm currentl( !as - million s!ares outstandin' at 6 20 per s!are& (*ax rate N 00.)
7!at is t!e firmEs optimal de%t ratio;
9"ta +t6 no d"bt s 1.50.
D , 9"ta 'ost o1 'ost
o1
%&'
'
0.5 0.5 2.40
":uty
0.2892
d"bt
0.14 0.186
6
opt
2a(
11. .on term financin.
@ou are anal()in' a converti%le preferred stoc$, wit! t!e followin' c!aracteristics for t!e securit(+
*!ere are 40,000 preferred s!ares outstandin', wit! a face value of 6-00 and a 3. preferred
dividend rate&
*!e firm !as strai'!t preferred stoc$ outstandin', wit! a preferred dividend rate of C.&
*!e preferred stoc$ is tradin' at 6-04&
Estimate t!e preferred stoc$ and equit( components of t!is preferred stoc$&
-a(u" o1 Stra76t Pr"1"rr"d Sto!; porton o1 'on)"rtb(" = 66.67
-a(u" o1 'on)"rson Porton = 38.33
12. Measurin Risk.
C!r(sler, t!e automotive manufacturer, !ad a %eta of -&04 in -CC4& t !ad 6-3 %illion in de%t
outstandin' in t!at (ear, and 344 million s!ares tradin' at 640 per s!are& *!e firm !ad a cas!
%alance of 6> %illion at t!e end of -CC4& *!e mar'inal tax rate was 33.
a& Estimate t!e unlevered %eta of t!e firm&
%& Estimate t!e effect of pa(in' out a special dividend of 64 %illion on t!is unlevered %eta&
c& Estimate t!e %eta for C!r(sler after t!e special dividend&
a. b
<tota(
= .715
b. b
<,auto
= .
966
*"+ b
<
= 0.853
!. *"+ b
.
=
1.41
13. Cost of capital
*!e Oimited 2roup8s assets !ave a total mar$et value of 6-,000 million& 6300 million of t!e
asset value is in t!e compan(Es clot!in' division, w!ic! !as an unlevered %eta of -&2& *!e ot!er
6000 million of t!e asset value is in t!e compan(Es specialt( retailin' division& *!e compan(8s
equit( (levered) %eta is -&>& *!e compan(8s current outstandin' de%t is wort! 6240 million& 6200
million of t!is de%t is allocated to t!e clot!in' division& *!e rest of t!e de%t is in t!e specialt( retail
division&
*!e compan( !as Kust announced t!e acquisition of J5 "!oes, a small footwear compan(&
J5 is a private compan( and !as no de%t in its capital structure& *!e Oimited8s investment %an$ers
estimate t!at J5 !as a %eta of -&4& *!e Oimited is 'oin' to raise t!e necessar( 640 million for t!e
acquisition %( issuin' new de%t& *!is new de%t, as well as t!e newl( acquired assets, will %e
allocated to *!e Oimited8s specialt( retailin' division&
7!at are *!e Oimited8s divisional asset (unlevered) %etas after t!e acquisition; 7!at will
t!e %eta %e for t!e compan(8s stoc$ after t!e acquisition; 9ssume t!at *!e Oimited !as a 00. tax
rate&
b
un(")"r"d,'(ot6n7
= 1.2
b
<,n"+ S0
= 1.90
*"+ (")"r"d b"ta3 b
.
= =
1.86
14. Risk & Return
@ou run a re'ression of B@< stoc$ returns a'ainst t!e mar$et returns usin' mont!l(
o%servation over a five, (ear period& @ou !ad an intercept of 0&20. and a slope of -&20& Pver t!is
time period, B@<8s stoc$ return !ad an annuali)ed standard deviation of 00. w!ereas t!e mar$et
standard deviation was onl( 20.& *!e ris$ free rate !as %een 3. on avera'e over t!e last five
(ears, and currentl( it is at 1.& *!e !istorical ris$ premium !as %een >&4.& *!e annuali)ed
dividend per s!are currentl( is 62&00, and t!e stoc$ is currentl( sellin' at 640& *!ere are -00,000
s!ares outstandin'&
(a) 7!at proportion of B@< ris$ is diversifia%le;
(%) 7!at would (ou expect B@<8s stoc$ price to %e one (ear from toda(;
(c) B@< currentl( !as 64 million in de%t outstandin' and its mar'inal tax rate is .00& B@< is
plannin' on sellin' one of its divisions for 64 million& *!is division !as an asset %eta of 0&4&
B@< will use t!e proceeds from t!e sale to pa( 63 million as dividends to its stoc$!olders& *!e
rest will %e used to retire de%t& 7!at will t!e %eta %e after t!is restructurin';
4a5 1 = 0
2
= 0.64 > d)"rs1ab(" rs;
4b5 P
1
= /56.6
4!5 b
&?@,0
=
1.9
1u(( so(utons
1) Portfolio risk an) return
IS = 4=10=4A4A12A20585 = 4.4
DS = 42A7A6A4A4585 = 4.6
s
2
IS
= .2B4=.10=.0445
2
A4=.04=.0445
2
A4.04=.0445
2
A4.12=.0445
2
A4.2=.0445
2
C = 0.011584
s
2 2 2
2 2 2
DS
= .2B4.02=.0465 A4.07=.0465 A4.06=.0465 A4.04=.0465 A4.04=.0465
C = 0.000304
s
DS
= B4=.10=0.4454.02=.0465A 4=.04=0.4454.07=.0465A 4.04=0.4454.06=.0465A 4.12=0.445
4.04=.0465A 4.20=
0.4454.04=.0465C = .000056
r
IS,DS
= 4.000056584D.0115845 4D.0003045 =
0.0298 r
p
= .5E4.4A.5E4.6=4.5
s
P
= B.5
2
E.00304 A .5
2
E.011584 A 2E.5E.5E.000056C
182
= .05477
2)
CAPM
r
2
= .145
r
1
= .07
b
;
= 1.2
,4r
;
5 = .06 A 1.24.145=.065 = .162
P = 45E1.01584.162=.015 = 33.22
b. ,4r
MF
5 = .15
b
MF
= 1.5
1
st
. 'o2par" rs; r"+ard
ratos3 Mar;"t 4r
2
=r
1
58 b
2
= .
085
Gnd"r!ar" 4r
G
=r
1
58 b
G
= 4.162=.06581.2 = .085
Max!ar" 4r
MG
=r
1
58 b
MF
= 4.15=.06581.5 = .06
"xp"!t"d r"turn s too (o+ r"(at)" to syst"2at! rs;, dont buy
Max!ar". Hr, 2
nd
1ro2 '&PM3
,4r
MF
5 = .06 A 1.5E4.145=.065 = .1875
Sn!" r"turn s (o+"r t6an t6at pr"d!t"d by '&PM 4b"(o+ s"!urty 2ar;"t (n"5, donIt buy t.
3) CAPM
s
# 2
=r
# 2
s
#
s
2
= .2E.1E.12 = .
0024 b
J
=s
#2
8s
2
2
= .
00248.1
2
=.24
r
#
=.055A.24E4.14=.0555
=7.54$
4. Cost of capital
D3 /100M. ?-, 10$ !oupon rat", s"2=annua( p2ts.
10 yrs to 2aturty, K@M 8$
M-
D,9@
= /580.04 L1= 181.04
20
M A /100841.045
20
= 113.59M
M-
,N<I@K
= 41 M54 /505 = / 50 M > M-
?I0M
= 113.59 A 50 = 163.59
b = 1.5
@=9(( rat" = 5$ > 0s;=pr"2u2 = 8.5
$ @ = 40$
r
"
= 5$ A 41.5548.5$5 = 17.75$
r
%&''
= 4508163.595 E 417.75$5 A 4113.598163.595 E 41= 0.45 E 48$5 = 8.76$
5. Risk & Return: Estimatin !eta.
a)" b"ta = 1.1 O a)" D8, = .327
b
un(")
= 1.18L1A.32741=.355M = .907
". Cost of capital
a.
<n(")"r !o11"" b"ta3
1.3841A41=.365.65=.9393
<n(")"r ,nst"n b"ta3
.9841A41=.365.85 = .595
*"+ ,nst"n un(")"r"d b"ta3
80$E.595 A 20$E.9393 = .66386
*"+ ,nst"n (")"r"d b"ta3
.6641A41=.365.85=1
!.
!ost o1 !apta(3
r
d
= .11
r
"
= .07 A 1E.055 = .125
D8- = .881.8 = .444
,8- = 181.8 = .556
%&'' = .881.8E.11E41=.365 A 181.8E.125 = 10.07$
&. Capital (tructure: Mo)iliani Miller *+eorems
a. -
.
= -
<
A @
'
9 = ,9I@41=@
'
58r
0
A @
'
9 = /84.6658.12 A .34E/15 = /49.1
b. 0
S
=r
0
A98S4r
0
=r
9
541=@
'
5 = .12 A L1584 49.1=155ME4.12=.085E.66 = 13.16$
,. Capital (tructure *+eor-
a.
. *"+ 1r2 )a(u"3 /640,000 4MM Prop I5
. S6ar" pr!" = 640,000832,000 = /208s6ar"
*u2b"r o1 s6ar"s r"pur!6as"d = 300,000820 = 15,000
'apta( stru!tur" = D A , = 300,000 A 340,000
M-, = 340,000
*u2b"r o1 s6ar"s outstandn7 = 32,000 = 15,000 = 17,000
S6ar" pr!" = /208s6ar"
b.
Hr7na( 1r2 )a(u" = 5,000E7 = 35,000
@ax s6"(d = @
!
9 = .25410,0005 = 2,500
*"+ 1r2 )a(u" = 37,500
37,500 = DA, = 10,000 A , O , = 27,500
C& Capital (tructure.
'urr"nt )a(u" o1 ":uty = /400 2((on
'urr"nt )a(u" o1 d"bt = /250 2((on
'ost o1 ":uty = .06 A 1.0E.055 = 11.5$
'ost o1 d"bt = 8$
'urr"nt %&'' = 2508650E8$E41=.45 A 4008650E11.5$ = 8.92$
*P- o1 proP"!t a!!ru"s to ":uty, so ,:uty = /400 Q /30 = /80 A /30 = /320
D"bt = /250 A /150 = /400
*"+ D8, rato = 4008320
<n(")"r"d b"ta = 1841A0.6E25084005 = 0.727
*"+ (")"r"d b"ta = 0.727E41A0.6E400832055 = 1.27
*"+ !ost o1 ":uty = .06 A 1.27E.055 = 13$
*"+ %&'' = 4008720E10$E41=.45 A 3208720E13$ = 9.11$
-0& Capital (tructure.
9"ta +t6 no d"bt s 1.50. *""d to !a(!u(at" n"+ b"ta as D8, !6an7"s.
D , 9"ta 'ost
o1
":u
'ost
o1
d"b
%&
''
0 1 1.50 0.2145 0.10 0.21
45 0.1 0.9 1.60 0.2228 0.11 0.20
68
0.2 0
.
1.73 0.2332 0.11 0.1997
0.3 0
.
1.89 0.2465 0.12 0.1942
0.4 0
.
2.10 0.2643 0.13 0.1898
0.5 0
.
2.40 0.2892 0.14 0.1866
opt2a( 0.6 0
.
2.85 0.3266 0.16 0.1882
0.7 0
.
3.60 0.3888 0.18 0.1922
0.8 0
.
5.10 0.5133 0.20 0.1987
0.9 0
.
9.60 0.8868 0.25 0.2237
11. .on term financin.
-a(u" o1 Stra76t Pr"1"rr"d Sto!; porton o1 'on)"rtb(" = 68.09 = / 66.67 R P"rp"tua( .1"
-a(u" o1 'on)"rson Porton = / 105 = / 66.67
=
/ 38.33
12. Measurin Risk.
9"1or"
'as6 8 b((on D=13 b((on
&uto 22.75
b((on
,=17.75
b((on
b
un(")"r"d
= 1.058L1A13817.75E41=.365M = .715
b
!as6
= 0
b
<
= .715 = b
<,auto
E22.75830.75 A b
!as6
E8830.75
b
<,auto
= .966
&1t"r
'as6 3 b((on D=13 b((on
&uto 22.75
b((on
,=12.75
b((on
*"+ b
<
= b
<,auto
E22.75825.75 A b
!as6
E3825.75 = 0.853
*"+ b
.
= 0.853EL1A13812.75E41=.365M = 1.41
13. Cost of capital
b
.")"r"d,'.H@SI*TAS0
= 1.8
b
un(")"r"d,'(ot6n7
= 1.2
b
0G
= 1.5
9,?H0,
&3 /600M D3 /200M
4'(ot6n7 d)son5 ,3 /400M
&3 /400M
4S0 d)son5
D3 /50
,3 /350
&
?
@
,
0
&3
/600M
D3
/200M
4'(ot6n
7
d)son5
,3
/400M
&
3

/
4
5
0
M

4
S
0

d

o
n
5
D3 /100
,3 /350
D
b
.
= b
<
E
- (- T)
E
1.8 = b
<,'H@SI*
TAS0
E -
0
&
3
2
4
0
1
4
0
b
<,
'.
H@
SI
*T
AS
0
=
1.
50
b"
1o
r".
b
<,'.H@SI*TAS0
= 1.5 = 60081000 E 1.2 A
40081000 E b
<,S0
O b
<,S0
= 1.95
&1t"r, b
<,n"+ S0
= 4008450 E 1.95 A 508450 E 1.5
= 1.90
So ass"t b"ta 1or n"+ S0 d)son = 1.90O ass"t
b"ta 1or !(ot6n7 d)son ":ua(s or7na( 1.2
*"+ (")"r"d b"ta3 , b
<,n"+ tota(
= 60081050 E 1.2
A 45081050 E 1.9 = 1.50
300
b
.
=
1.50 E
-
0
&
3
1
4
0
= 1.86
14. Risk & Return
a = 0.30$, b= 1.20
0

= r
1
A 94r
2
= r
1
5 = 41=
95 r
1
A 9r
2
s
x
y
#

=

0
.
4
,

s
2

=

0
.
2
r
1

=

6
$

4
6

s
t
o
r

!
a
(
5

4
7
$

n
o
+
5
r
1

=

r
2

=

8
.
5
$

D

=

/
2
8
s
6
a
r
"

P
o

=

/
5
0
n

=

1
0
0
,
0
0
0

s
6
a
r
"
s
2 2 2 2 2
4
a
5
0
2
=
b
2
s
2
8
s
xy
#
=
1
.
2
4
0
.
2
5
8
4
0
.
4
5
= 0.36
>
syst"2
at!
1 = 0
2
= 1 = 0.36 = 0.64 > d)"rs1ab(" rs;
4b5 r
xy#
= 7$ A 1.248.5$5 = 17.2$
4P
1
A 2 Q 505 8 50 = 17.2 $ > P
1
= /56.6
4!5
9"1or"
& = /10 M D = /5 M
, = 100,000 E 50 = /5 M
b
,
= 1.2 O 1.2 = b
u
E L 1 A 0.6 45855 M > b
u
= 0.75
b
u
= 0.75 = 182 40.55 A 182 b
u
, 2 > b
u
,2 = 1
&1t"r
& = /5 M D = /3M
, = /2 M
> b
&?@,0
= 415 E L1 A 0.643825 M = 1.9
additional pro%lems done in class+
Quic$ /art is a small convenience store t!in$in' of addin' a donut s!op in t!e store to serve
t!eir commutin' customs8 %rea$fast& *!e( !ave complied t!e followin' information on
companies in t!e donut %usiness+
Compara%le firm ?eta #e%tAEquit( ratio
5risp( CrRme -&2 0&2
#un$in #onut -&1 0&4
=S= -&3 0&14
*!e appropriate corporate tax rate is 30., and Quic$ /art8s mana'ement !as set a tar'et #AE ratio of &3
for t!e donut proKect& *!e mar$et ris$ premium is 3., and t!e ris$ free rate is 4.&
a& Estimate an unlevered %eta usin' t!e compara%le
firms& %& Estimate t!e levered %eta for t!e new proKect&
c& Estimate t!e cost of equit( for t!e donut s!op&
"olution
9vera'e %etaN-&0
9vera'e #AEN0&0>33
Hnlevered %etaN-&0A(-M(-,0&30)T0&0>22)N-&03-0
-&03-0T(-M(-, 0&30)T0&3)N-&21-3
0&04M-&21-3T0&03N0&-233
/easurin' ris$
@ou !ave run a re'ression of 9? Corp8s stoc$ returns a'ainst t!e mar$et and determined its equit(
%eta is
-&4& *!e compan( !as, in mar$et value terms, 6400 million of de%t and 6400 million of equit(& *!e
compan( currentl( !as two divisions& #ivision 9, w!ic! !as a mar$et value of 6300 million,
produces dis$ drives and (ou find 4 listed companies on t!e I@"E w!ic! made onl( dis$ drives&
*!ese companies !ave an avera'e %eta of -&3- and an avera'e de%t equit( ratio of 20.& #ivision ?
produces memor( c!ips and (ou cannot find an( compara%le companies& 9ssume all companies
face a tax rate of 40.&
a& 7!at is t!e asset (unlevered) %eta for division ?;
%& f t!e compan( divests itself of #ivision ? and increases its de%t equit( ratio to 2, w!at
would t!e compan(8s %eta %e;
"olution
O,9?
N-&4
A$"%% /$5%%
0$4%% E$5%%
O,9comps
N-&3-
#AE of 9comps N0&2
H,9comps
N-&3-AU-M(-,0&4)T0&2VN-&3-A-&-N-&-C
H,9?
N-&4AU-M(-,0&4)T-VN-
-N
H,9?
N300A-000T
H,9
M000A-000T
H,?
N0&3T-&-CM0&0T
H,? H,?
N0&1-4
O,9
N
H,9
TU-M(-,0&4)T2VN-&-CT2N2&3>