--%>

Problem on leveraged beta

AB Restaurants has debt/equity ratio .25, and its leveraged beta is 1.5. Its tax rate is 30%, and its cost of equity is 15%. The risk-free rate is 5%. CD Restaurants has debt/equity ratio .4, and tax rate 35%. Find the cost of equity for CD.

E

Expert

Verified

AB’s Cost of equity = 15% = 5% + 1.5 (Rm - 5%)
1.5 Rm = 17.5%
Rm = 11.67%
Bu = BL/(1 + (1 – T)(D/E)) = 1.5/(1 + (1 – 0.3)(0.25) = 1.5/1.175 = 1.277

Hence with a D/E ratio of 40%,

BL = BU (1 + (1 – T)(D/E)) = 1.277 (1 + (1 – 0.35)(0.4)) = 1.61

Cost of equity = 5% + 1.61*(11.67% - 5%) = 15.72%

   Related Questions in Corporate Finance

  • Q : Tax benefits of lease FedEx would like

    FedEx would like to acquire 300 vans for its business. It can buy each van for $35,000, depreciate it completely over 5 years, and then sell it for $10,000. The tax rate of FedEx is 30%, and its cost of debt is 10%. Avis Fleet Rental will lease these vans to FedEx for

  • Q : Cost of Equity AB Corporation has 16%

    AB Corporation has 16% cost of equity, 35% tax rate, and debt-to-equity ratio of 30%. XY Corporation has 30% tax rate and debt-to-equity ratio of 40%. Both AB and XY are in the same business of selling automotive parts. If the riskless rate is 4% and the expected retu

  • Q : Selling or purchasing problem Atlas

    Atlas Realty Company is interested in buying a house and renting it out for $12,000 a year, collecting the rent in advance each year. This will depreciate the house over 25 years; however sell it after 15 years at twice its purchase price. The maintenance expenditures

  • Q : Weighted return and simple return to

    What is the difference between weighted return and simple return to shareholders?

  • Q : Capital Structure Case Study 1 You work

    Case Study 1 You work in Walt Disney Company's corporate finance and treasury department and have just been assigned to the team estimating later today. You quickly realize that the information you need is readily available online. 1) Go to http://finance.yahoo.com. under " Market Summary," you

  • Q : Problem on Zero coupon bonds

    Robertsons, Inc. is planning to enlarge its specialty stores into 5 other states and finance the expansion by issuing 15-year zero coupon bonds with a face value of $1,000. When your opportunity cost is 8 % and similar coupon-bearing bonds will recompense semi-annuall

  • Q : Problem on stock market John Wong is a

    John Wong is a fresh graduate and has a limited amount of funds for investments. He expects that the Hong Kong stock market will fall soon but he is not familiar with derivatives. In order to gain more money to buy a car, he explores engaging in Hang Seng Index (HSI)

  • 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 : Define Capital Projects Capital

    Capital Projects: It is a long-term investment made in order to build on, add or enhance on a capital-intensive project. A capital project is any undertaking that requires the usage of notable amounts of capital, together with financial and labor, to

  • Q : Data Case Please assist with the

    Please assist with the attached Data Case assignment