1.Weston Enterprises is an all-equity firm with three divisions. The soft drink division has an asset beta of 0.60, expects to generate free cash flow of $50 million this year, and anticipates a 3% perpetual growth rate. The industrial chemicals division has an asset beta of 1.20, expects to generate free cash flow of $70 million this year, and anticipates a 2% perpetual growth rate. Suppose the risk-free rate is 4% and the market risk premium is 5%.
a. Estimate the value of each division.
b. Estimate Weston’s current equity beta and cost of capital. Is this cost of capital useful for valuing Weston’s projects? How is Weston’s equity beta likely to change over time?
2.Harrison Holdings, Inc. (HHI) is publicly traded, with a current share price of $32 per share. HHI has 20 million shares outstanding, as well as $64 million in debt. The founder of HHI, Harry Harrison, made his fortune in the fast food business. He sold off part of his fast food empire, and purchased a professional hockey team. HHI’s only assets are the hockey team, together with 50% of the outstanding shares of Harry’s Hotdogs restaurant chain. Harry’s Hotdogs (HDG) has a market capitalization of $850 million, and an enterprise value of $1.05 billion. After a little research, you find that the average asset beta of other fast food restaurant chains is 0.75. You also find that the debt of HHI and HDG is highly rated, and so you decide to estimate the beta of both firms’ debt as zero. Finally, you do a regression analysis on HHI’s historical stock returns in comparison to the S&P 500, and estimate an equity beta of 1.33. Given this information, estimate the beta of HHI’s investment in the hockey team.