--%>
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 : 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 : Calculating the Cost of Equity You are

    You are an analyst in the financial division of Flipper Industries (FI) which has a beta of 1.80 (you are risk-philic, so you enjoy the thrill of working somewhere so risky). The company just paid a dividend of $1 and dividends are expected to grow at 5% per year. The

    		•
  • Q : Could we explain that the shares’ value

    Could we explain that the shares’ value is intangible?

    		•
  • 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 : Affect the value of the stock Is the

     Is the value of this stock dependent on how long you plan to hold it? In other words, if your planned holding period were 2 years or 5 years rather than 3 years, would this affect the value of the stock today, P0? Explain your answer.<

    		•
  • Q : Types of lease contracts What are the

    What are the types of lease contracts which are seen in practice?

    		•
  • Q : Problem on financial manager

    Assume that you are a financial manager of Yuen Cheong Manufacturng Company. Due to the rising demand of product X, Yuen Cheong Manufacturng Company decides to open a new production plant in China, so it needs to take a loan of US$1 million. Bank A offers Yuen Cheong

    		•
  • Q : Problem on exponential growth rate

    Atlanta Company stock is predicted to follow an exponential growth rate. The relationship among the current stock price P0, future price PT after time T, and continuously compounded rate of the return r, is: PT = P0eγT. The stock doesn’t pay any

    		•
  • Q : DCF Analysis AB Corp. is in the

    AB Corp. is in the business of making white-board markers. They are computing the potential of investing in some new equipment that will enhance their manufacturing process.  The initial cost of the latest machinery is $470,000 plus a one-time installation cost o

    		•
  • Q : Does it make sense to apply identical

    The National Company responsible for the company where he work has newly published a document stating as that the levered beta of the sector of energy transportation is as 0.471870073 (it is 9 decimals). They acquired this number by considering the betas into the sect

    		•