--%>
Assignment Help - homework help

Evaluating Beta of a Corporation

Baldwin Corporation is planning to expand into the business of providing on-demand movies. Baldwin has debt-to-equity ratio of .25, its pretax cost of debt is 9%, and its marginal tax rate is 40%. The Harrington Corporation is already in the on-demand movie business, has a beta of 1.5, debt-to-equity ratio of 0.35, and marginal tax rate of 25%. What beta should Baldwin use in evaluating this project? What is the required return on the project if the riskless rate is 5% and the expected return on the market is 10%?

E

Expert

Verified

From the given details,
Harrington’s unlevered beta can be determined as
Bu = BL/(1 + (1 – T)(D/E)) = 1.5/(1 + (1 – 0.25)(0.35) = 1.5/1.2625 = 1.188
Hence with a D/E ratio of 0.25,
BL = BU (1 + (1 – T)(D/E)) = 1.188 (1 + (1 – 0.4)(0.25)) = 1.366
Cost of equity = 5% + 1.366*(10% - 5%) = 11.832%
Cost of debt = 9%*(1 – 0.40) = 5.4%
WACC = 0.8*11.832% + 0.2*5.4% = 10.55%

Thus beta is 1.366 and the required rate of return is 10.55%

   Related Questions in Corporate Finance

  • Q : Define capital goods Capital goods :

    Capital goods: Goods employed in producing other goods are termed as capital goods.

    		•
  • Q : Additive risk in the CAPM Suppose that

    Suppose that the two securities APPL and MSFT account for the entire large cap technology component of the S&P 500 (hypothetically – of course – there are really plenty of others). Further, suppose that their weights in the S&P index were as follow

    		•
  • Q : Markets are expected to be Volatile

    When Markets are expected to be Volatile: For the bear and bull strategy to yield gains, it is essential that the trader takes a view on the direction of the market i.e. either bearish or bullish, and accordingly implement the strategic choice. More o

    		•
  • Q : Define stock variable Stock variable :

    Stock variable: It is a variable whose value is measured or evaluated at a point of time.

    		•
  • Q : Problem on required rate of return

    Tudor Online Publishing Corporation has tax rate of 35%, debt-to-equity ratio of 25%, and has (leveraged) beta 1.25. The riskless rate is 3% and the market return is 12%. Windsor Publishing Company is an all equity company and is in the same business. What is the requ

    		•
  • Q : Historical return on stock market and

    The market risk premium is difference among the historical return upon the stock market and the risk-free rate, for yearly. Why is this negative for some years?

    		•
  • Q : Who explained market-neutral delta

    Who explained market-neutral delta hedging?

    		•
  • Q : Structure of Interest rates Which

    Which determines the shape of the term structure of Interest rates?

    		•
  • Q : Who explained put–call parity Who

    Who explained put–call parity?

    		•
  • Q : NPV and Other Investment Criteria The

    The XYZ Manufacturing Company is considering the below investment proposal. The initial investment is $100,000. It was an expected economic life of 10 years. The net cash flow in the initial year is expected to be $25,000 and annual net cash flow is expected to develo

    		•