Nero Violins has the following capital structure: What is the firm\'s asset beta

Question

Nero Violins has the following capital structure:

What is the firm's asset beta? (Hint: What is the beta of a portfolio of all the firm's securities?) (Do not round intermediate calculations. Round your answer to 3 decimal places.)

Assume that the CAPM is correct. What discount rate should Nero set for investments that expand the scale of its operations without changing its asset beta? Assume a risk-free interest rate of 4% and a market risk premium of 5%. (Do not round intermediate calculations. Round your answer to 3 decimal places.)

Assume that the CAPM is correct. What discount rate should Nero set for investments that expand the scale of its operations without changing its asset beta? Assume a risk-free interest rate of 4% and a market risk premium of 5%. (Do not round intermediate calculations. Round your answer to 3 decimal places.)

  Security Beta Total Market Value
($ millions)   Debt 0         $ 115      Preferred stock 0.35         55      Common stock 1.35         314   

Explanation / Answer

a)

Firm Value asset = 115 + 55 + 314 = 484

?a = (115/484)*0 + (55/484)*0.35 + (314/484)*1.35 = 0.9156

b)

r = 0.04+0.9156*0.05 = 0.08578 = 8.578 %

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