Hearty Plc is currently considering buying another company in a completely new area. The purchase has an
Question:
Hearty Plc is currently considering buying another company in a completely new area. The purchase has an IRR of 12%.
Hearty Plc's current WACC is higher than this and the project would usually be rejected however the directors have stated that because this is a completely new project in a new area that they should use a proxy beta of another company to recalculate a project beta and project WACC. The Directors have decided to use the CAPM for this.
They have selected three companies in the area as possible comparators:
• Company A has an equity Beta of 1.33 and has an equal split between equity and debt within its capital structure.
• Company B has an equity Beta of 1.3. However, it recently bought a company which accounts for 20% of its value which has a beta of 1.4. This company is financed by 40% debt and 60% equity.
• Company C has an equity Beta of 1.05 and has a capital structure of 35% debt and 65% equity.
You should assume that all companies are profit making and pay tax at a 30% rate. Hearty Plc is currently financed by 30% debt and 70% equity. The risk free rate of return is 5% and the return on the market is 9%.
The proxy asset beta for Company B is 0.758.
Demonstrate how this is calculated.
Fundamentals of Financial Management
ISBN: 978-0324664553
Concise 6th Edition
Authors: Eugene F. Brigham, Joel F. Houston