--%>
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 : Analysis on Stock Prices Using the last

    Using the last 3 years of closing stock prices on the first trading day of each month from January,  2010 through December 2012 for Apple (APPL) and the S&P 500 (market) for the same date range 1)    &n

    		•
  • Q : What is real gross domestic product

    Real gross domestic product: If GDP of a particular year is estimated or evaluated on the basis of the base year prices it is termed as real gross domestic product.

    		•
  • Q : Explain the definition of WACC An

    An investment bank computed my WACC. The report is as: “the definition of the WACC is defined as WACC = RF + βu (RM – RF); here RF being the risk-free rate and βu the unleveraged beta and RM the market risk rate.” It is differ from what we

    		•
  • Q : In which cases use different WACCs Is

    Is this possible to use different WACCs within order to discount each year’s flows? In which cases?

    		•
  • Q : Explain the working of breakthrough for

    Explain the working of breakthrough in low-discrepancy sequences used for option valuation.

    		•
  • Q : Effective annual yield problem Stanley

    Stanley invested in a municipal bond which promised an annual yield of 6.7 %. The bond pays coupons twice a year. What is the effective annual yield (abbreviated as EAY) on this investment? (1) 13.4%  (2) 6.81%  (3) 6.70%  (4) None of the above

  • Q : Discounting Free Cash Flow or

    Which of these two ways is better: discounting the Free Cash Flow or discounting the Equity Cash Flow?

    		•
  • Q : State capital formation Capital

    Capital formation: It is an increase in the stock of capital in particular period is termed as capital formation.

    		•
  • Q : Financial problem regarding acquistion

    My Company paid an extremely higher price for the acquisition of other company; the price was recommended through the valuation of an investment bank. Now we have financial problems. So is there any way to make this bank legally responsible for such situation?

    		•
  • 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.<

    		•