Question

Consider the following data for five metal producers in mid-2009 (all numbers are made-up for the purpose of the exercise):

Company	Market Capitalization ($mm)	Total Enterprise Value ($mm)	Equity Beta	Debt Rating
Shougang Group (China)	4500	8000	1.1	B
Southern Copper (USA)	3800	7200	1.3	AAA
US Steel (USA)	2400	3800	0.9	BBB
RusAl (Russian Aluminium)	1500	4400	1.75	BB

Suppose you were considering expanding your business into metal production, and need to estimate cost of capital of your project. You estimated that applicable risk free rate is 3% and market expected return is 8%.

1. Estimate asset beta for the metal industry.
2. Compute cost of capital of the project if it is going to be 100% equity financed.
3. Which betas have more dispersed values – equity betas or asset betas?

Answer 1

Asset beta= Equity beta/[1+(1-taxrate)*D/E] ------ tax rate is not given; hence taking as zero

where ; E=Equity value or market value ; D=Debt value =Enterprise value- E

Asset beta of Shougang Group (China):

Asset beta = 1.1/[1+(8000-4500)/4500] =.61875

Asset beta of Southern Copper (USA)

Asset beta = 1.3/[1+(7200-3800)/3800] =.68611

Asset beta of US Steel (USA)

Asset beta = .9/[1+(3800-2400)/2400] =.56842

Asset beta of RusAl (Russian Aluminium)

Asset beta = 1.75/[1+(4400-1500)/1500] =.59659

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Estimated Asset Beta for metal (Be)= average asset beta of all companies= ( .61875+.68611+.56842+.59659)/4 =.61747

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For 100% equity finance asset beta of project=equity beta of project

Cost of capital= risk free rate+ Be*(market return-risk free rate)

= 3+.61747*(8-3) =6.087%

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Equity betas have more dispersed value compared to asset beta. This is because Equity beta considers the capital structure of the firm and is dependent on how much debt a company is holding in its account.

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