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Please show formulas and calculations and not just results and numbers, and explain rationale for answers. Whenever applicable, interest is compounded annually and payments occur at the end of the period. Face value for bonds is $1000.

Davidson Inc. has 2 operating divisions. Davidson wants to estimate the cost of capital for each division and for the firm. Assume all debt is risk-free. Ignore taxes. The risk-free rate is 2.5% and the market risk premium is 10%. Firm Equity Beta Debt Ratio = Debt/Value Division’s % of overall Firm Value Atlas Foods .80 .40 40% Lace Linen 1.50 .20 60%

a. Estimate the asset beta for each division and for the firm. The asset beta is a weighted average of the debt beta (which is 0) and the equity beta.

b. Davidson’s management uses the firm’s overall asset beta in evaluating both divisions. Is this a good idea? Explain.

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Collen Von
Collen VonLv2
28 Sep 2019

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Please show formulas and calculations and not just results and numbers, and explain rationale for answers.

TRM has 2 operating divisions.TRM wants to estimate the cost of capital for each division and for the firm.Assume all debt is risk-free. Ignore taxes.The risk-free rate is 2.5% and the market risk premium is 10%.

Firm

Equity Beta

Debt Ratio = Debt/Value

Division’s % of overall Firm Value

Atlas Foods

.80

.40

40%

Lace Linen

1.50

.20

60%

1. Estimate the asset beta for each division and for the firm.The asset beta is a weighted average of the debt beta (which is 0) and the equity beta.

2. TRM’s management uses the firm’s overall asset beta in evaluating both divisions.Is this a good idea? Explain.

You were recently appointed the CFO of a firm with two divisions. Division 1 produces regular telephones. Division 2 produces specialty micro-chips which are used in cell phones. The market value of your firm’s debt is $100 million and the market value of your firm’s equity is also $100 million. The overall value of your firm is thus $200 million. The beta of your firms’ equity is currently 2 and your firm’s debt is riskless. The expected excess return on the market over the riskless rate is 8 percent and the risk-free rate is 2 percent. Assume that the CAPM holds.

a) Calculate the asset beta for your firm.

Suppose that you cannot identify a firm that is comparable in systematic risk to your cell phone division (Division 2), but do manage to identify a single-segment telephone firm, firm X, whose underlying business has systematic risk (asset beta) identical to that of your telephone business (Division 1). This firm has an equity beta of 1.0, a debt beta of 0.1, and a debt-to-equity ratio of 0.5. Furthermore, you expect total cash flow (to the asset) from Division 1 to be $10 million per year indefinitely (from t=1 onward).

b) What is the value of Division 1? What is the value of Division 2? (Hint: Start by working out the asset beta of Division 1)

Engineers in Division 2 now discover an opportunity to invest in a new production technology which would enable it to produce better micro-chips. The required investment would be $15 million today (t=0), but the investment would increase expected Division 2 sales revenues by $4 million per year (each year, indefinitely, starting at t=1). You should assume that the systematic risk (the asset beta) of Division 2 will be unaffected by the switch to the new production technology.

c) What is the asset beta for Division 2? Would you recommend that your firm invests in the new production technology?

d) Suppose your firm announces at t=0 that it will invest in the new production technology and issues $15 million worth of debt to finance the upfront investment. If there are 10 million shares outstanding, what will the price per share be right after this has been done (i.e. right after t=0)?

Your company has two​ divisions: One division sells software and the other division sells computers through a direct sales​ channel, primarily taking orders over the internet. You have decided that Dell Computer is very similar to your computer​ division, in terms of both risk and financing. You go online and find the following​ information: Dell's beta is 1.24​, the​ risk-free rate is 4.5 %​, its market value of equity is $ 65.6 billion, and it has $ 691 million worth of debt with a yield to maturity of 6.3%. Your tax rate is 38 % and you use a market risk premium of 5.2% in your WACC estimates.

a. What is an estimate of the WACC for your computer sales​ division?

The weighted average cost of capital for your computer sales division is __%? (Round to two decimal​ places.)

b. If your overall company WACC is 12.1% and the computer sales division represents 38% of the value of your​ firm, what is an estimate of the WACC for your software​ division?

The WACC for your software division is ___%? (Round to two decimal​ places.)

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