Question

  XYZ Inc. is a small firm currently operating in Ohio and is planning a new project

       in Illinois. The CEO of the firm gathered the following data to estimate the

       project’s cost of capital:

Comparable Public Firm XYZ Inc.’s  

Project

Market value of debt $220 m $82 m

Market value of equity $340 m $145 m

Marginal tax rate 36% 34%

Beta 1.7

The asset beta of XYZ Inc. is closest to:

A. 1.20.

B. 1.65.

C. 2.33.

D. 1.50

Answer 1

	Fisr we need to calculate unlevered beta using levered beta
	of Comparable Public Firm.
	Unlevered Beta
	= Levered Beta / {1+[Debt*(1-Tax Rate) / Equity]}
	= 1.70 / {1+[220*(1-36%) / 340]}
	= 1.70 / [1+(220*0.64 / 340)]
	= 1.70 / [1+(140.80 / 340)]
	= 1.70 / [1+0.4141]
	= 1.70 / 1.4141
	= 1.20
	Now, convert unlevered beta into levered beta by using
	debt and equity of XYZ Inc.
	Levered Beta / Asset Beta
	= Unlevered Beta * {1+[Debt*(1-Tax Rate) / Equity]}
	= 1.20 * {1+[82*(1-34%) / 145]}
	= 1.20 * [1+(82*0.66 / 145)]
	= 1.20 * [1+(54.12 / 145)]
	= 1.20 * [1+0.3732]
	= 1.20 * 1.3732
	= 1.65
	So answer is 1.65