Question

2. Safecorp currently has £500 million in debt and the market value of its equity is £800 million. Beta of its stock is 1.20. The company is planning a leveraged buyout (LBO) that will increase its debt-to-equity ratio to 5. If the marginal tax rate is 20%, what will be the equity beta of the firm after the LBO? (5 marks) 3. Beta plc is in steady state and has book value of equity of £500m. Its return on equity is 10%, cost of equity is 8%, and the payout ratio is 60%. a. What is the expected steady state growth rate for Beta plc? (2 marks) b. What is the value of equity of the company? (3 marks)

Answer 1

2.

Given,

Debt = $\pounds$ 500 million

Equity = $\pounds$ 800 million

Beta = 1.20

Expected debt-equity ratio = 5

Marginal tax rate (t) = 20% or 0.20

Solution :-

Unlevered beta Beta 7+ (1- t)(Debt le quity) 1.20 1 + (1 -0.20) (£500/£ 800) = 1 + 1.20 10.80)(0.675) 1.20 0.50 1 + 0.80 1.20 l. So

ratio New beta = Unlevered [1 +(1 – t) (expected debt-equity) beta = 0.80 [1 +(– 0.80) (5) ] = 0.80 [1 + (0.80)(5)] = 0.80 [1+4] - 0.80 [5] = 4. Thus, after the LBO the equity beta of the firm will be 4.