Beta?? commercial, currently, printing, business, expected

glamorous

Degen Company is considering a project in the commercial printing business. Its debt currently has a yield of 12%. Degen has a leverage ratio of 2.3 and a marginal tax rate of 30%. Hodgkins Inc., a publicly traded firm that operates only in the commercial printing business, has a marginal tax rate of 25%, a debt-to-equity ratio of 2.0, and an equity beta of 1.3. The risk-free rate is 3% and the expected return on the market portfolio is 9%. The appropriate WACC to use in evaluating Degen’s project is closest to:

A) 8.6%.

B) 8.9%.

C) 9.2%.

what do u think??

shootingstar

i think we should make our own notes and practice exams and sell them for extortionate amounts of money.

manasib

if financial leverage Assets/Equity = 2.3 then that means (E+L)/E = 2.3
2.3/1 = 2.3 then E+L=2.3, then L=2.3 - E, L= 2.3 - 1

kmf229

Because I'm such a nice guy.

unlevered b=levered b/(1+(1-T)(D/E))
unlevered b=1.3/(1+(.75)(2))
unlevered b=.52

Now relever

levered b=unlevered b(1+(1-T)(D/E))
levered b=.52(1+(.7)(2.3))
levered b=1.357

ke=rfr + b(mr-rfr)
ke=3 + 1.357(9-3)
ke=11.14

kd=yield*(1-t)
kd=12*(.7)
kd=8.4

Now solve for WACC. Be careful with the D/E ratio.

We=1/3.3=.303
Wd=1-We=.697

WeKe + WdKd=WACC (we already did the tax stuff)
.303*11.14 + .697*8.4= 9.22

cchang

If you see a problem like this on the test, you'll hear a chorus of groans from all of the Level I candidates when they see this question, don't even bother doing it until you've finished every other question.

You need to unlever your Beta with Hodgkins data and then relever using Degen data. Then you plug this Beta into CAPM to solve for Ke. Using the D/E ratio of Degen solve for the WACC components with the given inputs and adjust your debt for Tax.

The answer is C.