Assume that your company is made up of two divisions. Division 1 comprises 40 percent of the company while Division 2 makes up 60 percent of the company. The levered beta for the company as a whole is equal to 1.20 and the company's debt/value ratio is 50 percent (you may assume that appropriate values for Division 1 and 2 are also 50 percent). If the risk-free rate is 3.0 percent, the market risk premium is 6.00 percent, the marginal tax rate is 40 percent, and the before-tax cost of debt is 8.00 percent then, as you can calculate, the WACC for the company is 7.50 percent. As you can also calculate, using the Hamada equations, the unlevered beta for the company as a whole is 0.75. Now assume that other "pure" companies equivalent to Division 2 have an average unlevered eta of 0.61. Using this proxy for Division 2's unlevered beta, you should be able to etermine (back out) the unlevered beta for Division 1, re-lever both betas, calculate the
Assume that your company is made up of two divisions. Division 1 comprises 40 percent of the company while Division 2 makes up 60 percent of the company. The levered beta for the company as a whole is equal to 1.20 and the company's debt/value ratio is 50 percent (you may assume that appropriate values for Division 1 and 2 are also 50 percent). If the risk-free rate is 3.0 percent, the market risk premium is 6.00 percent, the marginal tax rate is 40 percent, and the before-tax cost of debt is 8.00 percent then, as you can calculate, the WACC for the company is 7.50 percent. As you can also calculate, using the Hamada equations, the unlevered beta for the company as a whole is 0.75. Now assume that other "pure" companies equivalent to Division 2 have an average unlevered eta of 0.61. Using this proxy for Division 2's unlevered beta, you should be able to etermine (back out) the unlevered beta for Division 1, re-lever both betas, calculate the
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Transcribed Image Text:Assume that your company is made up of two divisions. Division 1 comprises 40 percent of
the company while Division 2 makes up 60 percent of the company. The levered beta for the
company as a whole is equal to 1.20 and the company's debt/value ratio is 50 percent (you
may assume that appropriate values for Division 1 and 2 are also 50 percent). If the risk-free
rate is 3.0 percent, the market risk premium is 6.00 percent, the marginal tax rate is 40
percent, and the before-tax cost of debt is 8.00 percent then, as you can calculate, the WACC
for the company is 7.50 percent.
As you can also calculate, using the Hamada equations, the unlevered beta for the company
as a whole is 0.75.
Now assume that other "pure" companies equivalent to Division 2 have an average unlevered
beta of 0.61. Using this proxy for Division 2's unlevered beta, you should be able to
determine (back out) the unlevered beta for Division 1, re-lever both betas, calculate the
corresponding cost of equity, and then determine the appropriate WACC for each division.
(For the purposes of levering and un-levering betas, you may use the Hamada equations and
assume that the beta for debt is equal to zero.) Given this information, determine the
appropriate WACC for Division 1.
O 8.508%
O 7.972%
O 8.724%
O 8.447%
O 8.940%
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