--%>
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 : Public Finance which type of tax,

    which type of tax, direct or indirect is applicable in underdeveloped countries? Why? Show your critical areas and weaknesses.

    		•
  • Q : Which method must use to valuate young

    Which method must we use to valuate young companies along with high growth but uncertain futures? Two illustrations were Boston Chicken and Telepizza while they began.

    		•
  • Q : Variance of a portfolio The variance of

    The variance of a portfolio of 40 stocks will be the addition of _______ variance terms and _______ covariance terms. A) 40; 1560B) 40; 1600C) 80; 40D) 1600; 40

    		•
  • Q : Which frame work does not give very

    Which model of frame work does not provide the very good prices for bonds?

    		•
  • Q : Explain definition of put–call parity

    Explain the definition of put–call parity described by Reinach.

    		•
  • Q : Problem on Stock per share value ABC

    ABC Company plans to buy back 1 million shares of its own stock from its cash reserves at $50 a share. This will raise the bankruptcy costs by $10 million, and the debt/assets ratio from 35% to 40%. The income tax rate of the company is 30%. Determine the value of the

    		•
  • Q : Leverage ratio problem Handy Inc has

    Handy Inc has debt-to-assets ratio of 40%, tax rate of 35%, and total value of $100 million. W. C. Handy, the CFO, would like to increase the leverage ratio to 42%, and he believes that there will be no change in the bankruptcy cost of the company. How many dollars wo

    		•
  • Q : How present value of tax shields be

    I have two valuations of the company that we set as an objective. Within one of them, the present value of tax shields (D Kd T) computed using Ku (required return to unlevered equity) and, in one, by using Kd (required return to debt). The second valuation is too high

    		•
  • Q : Define capital goods Capital goods :

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

    		•
  • Q : Explain the Monte Carlo evaluation of

    Explain the Monte Carlo evaluation of integrals.

    		•