In: Finance
1. (a) Suppose Carter Chemical Company's
management conducts a study and concludes that if Carter expands
its consumer products division (which is less risky than its
primary business, industrial chemicals), the firm's beta will
decline from 1.1 to 0.9. However, consumer products have a somewhat
lower profit margin, and this will cause Carter's growth rate in
earnings and dividends to fall from 7 percent to 6 percent. Should
management make the change? Assume the following:
E[RM]= 10%; RF=7.5%; D0 =$2.
Assume all the facts as given in part (a), except the one about the
changing beta coefficient. By how much would the beta have to
decline to cause the expansion to be a good one? (Hint: set P0
under the new policy equal to P0 under the old one, and find the
new beta that produces this equality.)