You are analyzing the beta for a company and have broken down the company into four...
You are analyzing the beta for a company and have broken down the company into four broad business groups, with market values and betas for each group.
Mainframes= 2.0 billion, beta is 1.10
Personal Computers= 2.0 billion, beta is 1.50
Software= 1.0 billion, beta is 2.0
Printers= 3.0 billion, beta is 1.0
a. Estimate the beta for Ithe co as a company. Is this beta going to be equal to the beta estimated by regressing past returns on the co stock against a market index. Why or Why not?
b. If the treasury bond rate is 7.5%, estimate the cost of equity for IBM. Estimate the cost of equity for each division. Which cost of equity would you use to value the printer division?
c. Assume that the co divests itself of the mainframe business and pays the cash out as a dividend. Estimate the beta for the co after the divestiture. (the co had $ 1 billion in debt outstanding.)
Homework Answers
Answer A)
| Particulars | Market Value | Beta |
| Mainframe | 2 | 1.1 |
| Personal Computers | 2 | 1.5 |
| Software | 1 | 2 |
| Printers | 3 | 1 |
| Total | 8 | |
| Beta | 1.275 |
Beta is Weighted Average based the Market Value of the company.
Answer B)
Cost of Equity = Treasury Rate * Beta
| Particulars | Beta | Treasury Rate | Cost of Equity |
| Mainframe | 1.1 | 7.5 | 8.25 |
| Personal Computers | 1.5 | 7.5 | 11.25 |
| Software | 2 | 7.5 | 15 |
| Printers | 1 | 7.5 | 7.5 |
Answer C)
After divestiture of Mainframe Business the Beta of the company will be
| Particulars | Market Value | Beta |
| Personal Computers | 2 | 1.5 |
| Software | 1 | 2 |
| Printers | 3 | 1 |
| Total | 6 | |
| Beta | 1.333333333 |
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