Question 3. Beta and Cost of Capital DLT Inc. is a private company and has two lines of business: Oil&Gas and Energy Management, with 70% of the firm's sales generated by the Oil&Gas division. DLT has a target capital structure of 20% debt financing (D/V = 20%). The following table shows the financials of selected comparable companies (in $mm). Oil &Gas Energy Management Industry S&P500 50-50 70-30 Industry Portfolio 70% in Index portfolio Company OG Company EM Oil&Gas Target capital structure No Yes Tax Rate 40% 40% D/V 40% 10% Debt Beta Equity Beta 2.5 1.2 Standard Deviation of monthly stock returns over latest 3 years *Note: Generally we select more than one comparable companies in each industry, to reduce the error and 10% 7% noise in estimation. Additional market data and information: The 3-month Treasury bill yield is 1%. The 10-year Treasury note yield is 3%. The market risk premium is 5%. The marginal tax rate is 40%. (1) Use the following numbers to fill in the missing standard deviations of stock returns in the last row of the table. 9% 5% 12% (2) Calculate the asset beta and total beta of company OG and DLT. (3) Calculate the unlevered cost of equity (or unlevered cost of capital), cost of equity and cost of undiversified equity of DLT.
Question 3. Beta and Cost of Capital DLT Inc. is a private company and has two lines of business: Oil&Gas and Energy Management, with 70% of the firm's sales generated by the Oil&Gas division. DLT has a target capital structure of 20% debt financing (D/V = 20%). The following table shows the financials of selected comparable companies (in $mm). Oil &Gas Energy Management Industry S&P500 50-50 70-30 Industry Portfolio 70% in Index portfolio Company OG Company EM Oil&Gas Target capital structure No Yes Tax Rate 40% 40% D/V 40% 10% Debt Beta Equity Beta 2.5 1.2 Standard Deviation of monthly stock returns over latest 3 years *Note: Generally we select more than one comparable companies in each industry, to reduce the error and 10% 7% noise in estimation. Additional market data and information: The 3-month Treasury bill yield is 1%. The 10-year Treasury note yield is 3%. The market risk premium is 5%. The marginal tax rate is 40%. (1) Use the following numbers to fill in the missing standard deviations of stock returns in the last row of the table. 9% 5% 12% (2) Calculate the asset beta and total beta of company OG and DLT. (3) Calculate the unlevered cost of equity (or unlevered cost of capital), cost of equity and cost of undiversified equity of DLT.
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Transcribed Image Text:Question 3. Beta and Cost of Capital
DLT Inc. is a private company and has two lines of business: Oil&Gas and Energy
Management, with 70% of the firm's sales generated by the Oil&Gas division.
DLT has a target capital structure of 20% debt financing (D/V = 20%).
The following table shows the financials of selected comparable companies (in $mm).
Oil &Gas
50-50
Energy Management
Industry
S&P500
70-30
Portfolio
70% in
Oil&Gas
Industry"
Index
portfolio
Company OG
Company EM
Target capital structure
No
Yes
Tax Rate
40%
40%
D/V
40%
10%
Debt Beta
Equity Beta
2.5
1.2
Standard Deviation of
10%
7%
monthly stock returns
over latest 3 years
*Note: Generally we select more than one comparable companies in each industry, to reduce the error and
noise in estimation.
Additional market data and information:
The 3-month Treasury bill yield is 1%.
The 10-year Treasury note yield is 3%.
The market risk premium is 5%.
The marginal tax rate is 40%.
(1) Use the following numbers to fill in the missing standard deviations of stock
returns in the last row of the table.
9%
5%
12%
(2) Calculate the asset beta and total beta of company OG and DLT.
(3) Calculate the unlevered cost of equity (or unlevered cost of capital), cost of equity
and cost of undiversified equity of DLT.
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