Question

In: Finance

You’ve identified a comparable firm for a new division you are heading up. The comparable has...

You’ve identified a comparable firm for a new division you are heading up. The comparable has an equity beta of 1.4 and its debt has a beta of 0.3. The equity of the comparable has a market value of $30B and has $4B in debt outstanding. The market risk premium is 6% and the risk-free rate is 2%. What is the appropriate discount rate to use for your division’s assets/projects?

Solutions

Expert Solution

As per CAPM model

Cost of equity = risk free rate + beta of equity * market risk premium

Where, Cost of equity =?

Risk free rate = 2%

Beta of equity β =1.4

And market risk premium =6%

Therefore,

Cost of equity = 2% + 1.4 *6% = 10.4%

Debt is not risk-free as beta of debt is 0.3

Therefore,

Cost of debt = risk free rate + beta of debt * market risk premium

= 2% + 0.3 *6% = 3.8%

To calculate the appropriate discount rate to use for your division’s assets/projects; we have to calculate the weighted average cost of capital (WACC)

WACC = (E/ E+D) * re + (D/ E+D) * rd    (assume that there is no taxes)

Where,

re is the cost of equity = 10.4%

And rd is the cost of debt = 3.8%

D = value of Debt = $4B and E= value of Equity = $30B

Therefore,

WACC = ($40B/ $40B +$4B) * 10.4% + ($4B/ $40B +$4B) * 3.8%

WACC = ($40B/ $44B) * 10.4% + ($4B/ $44B) * 3.8%

= 9.45% + 3.5% = 9.8%

The appropriate discount rate to use for your division’s assets/projects is 9.8%

jeff jeffy answered 2 days ago
Next > < Previous

Related Solutions

You have been asked to replace the project manager who was heading up your firm’s new...
You have been asked to replace the project manager who was heading up your firm’s new compensation and benefits system. One of the reasons the project manager is being replaced is because the project schedule had the wrong resources assigned (e.g., resources who do not fully understand compensation and benefits). You have been asked to solve this problem quickly by either replacing the resources or getting the resources up-to-speed on compensation and benefits. Present your recommendation for solving this critical...
Introducing a New Product Consider a firm that is introducing a new product. The firm identified...
Introducing a New Product Consider a firm that is introducing a new product. The firm identified 300 potential customers whose probability of purchasing the product depends on age and gender as follows: Female Under 60 Probability Buy 0.6 Not 0.4 Female Over 60 Probability Buy 0.4 Not 0.6 Male Under 60 Probability Buy 0.55 Not 0.45 Male Over 60 Probability Buy 0.45 Not 0.55 Using the spreadsheet of customer data provided, estimate the average number of product demand in each...
Now that you’ve identified the organization’s SWOT, you need to determine the project and its objectives...
Now that you’ve identified the organization’s SWOT, you need to determine the project and its objectives and metrics. This project should be based on an unmet opportunity for the organization, or to minimize a potential threat. What does the organization need to do to advance its goals and/or expand its competitive advantage? How will you measure their progress? Complete the following: Explain why this opportunity/threat was selected, and how it is anticipated to benefit the organization. Create at least 3...
Netflix Now that you’ve identified the organization’s SWOT, you need to determine the project and its...
Netflix Now that you’ve identified the organization’s SWOT, you need to determine the project and its objectives and metrics. This project should be based on an unmet opportunity for the organization, or to minimize a potential threat. What does the organization need to do to advance its goals and/or expand its competitive advantage? How will you measure their progress? Complete the following: Explain why this opportunity/threat was selected, and how it is anticipated to benefit the organization. Create at least...
Netflix Now that you’ve identified the organization’s SWOT, you need to determine the project and its...
Netflix Now that you’ve identified the organization’s SWOT, you need to determine the project and its objectives and metrics. This project should be based on an unmet opportunity for the organization, or to minimize a potential threat. What does the organization need to do to advance its goals and/or expand its competitive advantage? How will you measure their progress? Complete the following: Explain why this opportunity/threat was selected, and how it is anticipated to benefit the organization. Create at least...
You have a new start-up firm. You think that the value of your start-up is around...
You have a new start-up firm. You think that the value of your start-up is around $60 million, but you will need to do a serious NPV analysis before you know the precise value. You are planning to have a 50% debt-to-value ratio, and that you will continuously rebalance to maintain this leverage. You have information on two other companies. The names of these companies are “Comp A” and “Comp B”. Comp A has the same business risk as your...
Consider a firm that is introducing a new product. The firm identified 300 potential customers whose...
Consider a firm that is introducing a new product. The firm identified 300 potential customers whose probability of purchasing the product depends on age and gender as follows: Female Under 60 Probability Buy 0.6 Not 0.4 Female Over 60 Probability Buy 0.4 Not 0.6 Male Under 60 Probability Buy 0.55 Not 0.45 Male Over 60 Probability Buy 0.45 Not 0.55 Using the spreadsheet of customer data provided, estimate the average number of product demand in each city: New York, Chicago,...
You’ve been hired by a firm as an analyst. They would like you to utilize the...
You’ve been hired by a firm as an analyst. They would like you to utilize the corporate valuation model in determining the stock price of Purina. You estimate the following cash flows for Purina. After the third year, you expect the growth rate to be 5%. Purina has $200 million currently in debt and 5 million shares of stock outstanding. Assuming an 8% required return, what is the intrinsic value of Purina’s stock? CF1 = $15 million CF2 = $25...
You’ve decided to take up business as a kale farmer; however, a disease has all but...
You’ve decided to take up business as a kale farmer; however, a disease has all but decimated the kale industry. You have a gene that can save the kale industry, make it resistant to this disease, but need to get it into the kale genome. Explain how you would insert a transgene into kale to provide it resistance against this disease.
You work for the ACME Corporation. The Anvil Division has a new idea for anvils that...
You work for the ACME Corporation. The Anvil Division has a new idea for anvils that explode when struck in a particular spot. You have been given the task of completing the financial analysis to determine whether the company should purchase the new anvils from a supplier or manufacture them internally. This will be a 5 year project. Unit sales are expected to be 500 anvils per year for each of the next 5 years. If ACME purchases the anvils...
ADVERTISEMENT
Subjects
ADVERTISEMENT
Latest Questions
ADVERTISEMENT