Mark Inc. is a privately held company, so there is no information about beta ava

Question

Mark Inc. is a privately held company, so there is no information about beta available. However, a company in the same business with a debt to equity ratio the same as that of Mark Inc. is publicly traded and has a beta of 1.75. If the risk-free rate is 3.8 percent, and the average market risk premium is 5.5 percent, what is the estimated cost of existing equity for Mark Inc.?

If a company has a beta of 1.25 and is considering a high risk project outside its normal course or business with a beta of 1.8, what beta should the company use? The 1.25 or the 1.8? Why?

A company is operating in three areas of the economy (sectors or industries) and the divisional betas are presented below:

Beta Value

Division A .75 $200,000

Division B 1.35 $300,000

Division C 1.80 $500,000

What is the company

Explanation / Answer

1. As per CAPM, rate of return on equity = rf + beta*(rm - rf)
rf = risk free rate = 3.8%
rm - rf = risk free premium = 5.5% and beta = 1.75

rate of return = 3.8% + 1.75*5.5% = 13.425%

2. The company should use 1.8 as its a high risk project and is different from the normal business of the company. The company should use its own beta of 1.25 for those projects only which are its normal business.

3. Beta = weighted average of the individual division's beta

= (0.75*200000 + 1.35*300000 + 1.80 * 500000 )/(200000+300000+500000) = 1.455

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