Patterson designs, sources, and sells branded t-shirts, jeans andother products primarily in the United States. The company
Question:
Patterson designs, sources, and sells branded t-shirts, jeans andother products primarily in the United States. The company currently has the following capital structure: $60 million in debt with a beta of 0.2 and $120 million in equity with a beta of 1.5. Assume that the given debt and equity values are market values. Assume further that the firm has no excess cash. Throughout this question (all parts) assume that the prevailing risk-free rate is 2% at all maturities, that the expected return on the market portfolio is 6%, and that the CAPM holds.
a) What is Patterson's beta of business assets (operations)?
b) What is its expected return on equity? Now, suppose Patterson issues $80 million of common stock, uses the proceeds to repurchase all of the debt at the current market value, and invests any leftover balances in risk-free investments.
c) What is now the beta of operations?
d) What is now the beta of the firm?
e) What is now the expected return on equity?
f) What discount rate should be used for investments that expand the scale of operations of Patterson in t-shirts, jeans, etc in the U.S.?
Business Statistics a decision making approach
ISBN: 978-0133021844
9th edition
Authors: David F. Groebner, Patrick W. Shannon, Phillip C. Fry