--%>

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 : Explain value of shares is Is this

    Is this correct that the value of the shares is, the “value of the results’ capitalization” that, as per to the Institute of Accounting and Auditing (ICAC) shows “the sum of the expected future results of the company throughout a certain period

  • Q : Define capital goods Capital goods :

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

  • Q : Convertible Bonds-Corporate Bonds State

    State the term Convertible Bonds in Corporate Bonds?

  • Q : Regarding WACC Regarding the WACC which

    Regarding the WACC which has to be applied to a project, must it be an expected return, the average historical return or an opportunity cost on similar projects?

  • Q : Problem on annual mortgage payment You

    You just took out a variable-rate mortgage on your new home. The mortgage value is $100,000, the term is 30 years, and initially the interest rate is 8%. The interest rate is fixed for 5 years, after which the time rate will be adjusted according to the prevailing rat

  • Q : Which frame work does not give very

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

  • Q : Purchaing or leasing problem Crawford

    Crawford Corporation is planning to lease a machine for the next 4 years for an annual lease payment of $3,000 paid in advance, plus a non-refundable initial fee of $3,000. There is a 1-year delay for the tax benefits of leasing. Crawford may buy the machine, deprecia

  • Q : Compute the present value of the

    Is this possible to value companies by computing the present value of the Economic Value Added (EVA)?

  • Q : Does value of the company increase when

    According to the valuation method depends on tax shields, the value of the company (Vl) is the value of the unleveraged company (Vu) in addition with the value of tax shields (VTS), thus, the higher the interest and the higher the VTS. Therefore, does

  • Q : Who proposed modern quantitative

    Who proposed a modern quantitative methodology for portfolio selection?