You run a regression of monthly returns of Mapco, an oil-and gas-producing firm, on the S&P 500 Index and come up with the following output for the period 1991–1995.
Intercept of the regression = 0.06%
X-coefficient of the regression = 0.46
Standard error of X-coefficient = 0.20
R2 = 5%
There are 20 million shares outstanding, and the current market price is $2/share. The firm has $20 million in debt outstanding. (The firm has a tax rate of 36%.)
a. What would an investor in Mapco’s stock require as a return, if the Treasure bond rate is 6%?
b. What proportion of this firm’s risk is diversifiable?
c. Assume now that Mapco has three divisions, of equal size (in market value terms). It plans to divest itself of one of the divisions for $20 million in cash and acquire another for $50 million (it will borrow $30 million to complete this acquisition). The division it is divesting is in a business line where the average unlevered beta is 0.20, and the division it is acquiring is in a business line where the average unlevered beta is 0.80. What will the beta of Mapco be after this acquisition?