14. Scout Companies and Radley Enterprise environment in terms of demand structu
ID: 2805264 • Letter: 1
Question
14. Scout Companies and Radley Enterprise environment in terms of demand structure, as detailed below: s are both in the same industry and face the same competitive as detailed belowablity and pricing power. However, the two firms differ in their cost Sales Price per Unit Variable Costs per Unit Fixed Costs Tax Rate Total Operating Capital Required Scout Companies $12 $10 $20,000 40% $200,000 Radley Enterprises $12 $6 $78,000 40% $400,000 Both com a. Scout Companies has the higher business risk. b. The firms have the same WACC c. Scout Companies must sell 15,000 units to break even. d. Radley Enterprises has the higher beta. panies are 100% equity financed, which of the following is most likely correct? 15. LaPorte Companies is considering a change to its existing capital structure. Currently, the firm has a capital structure that consists of 30% debt and 70% equity based on market values. The risk-free rate is 7.1% and the market risk premium is 6.1%. The firm's current cost of equity based on CAPM is 13.2% and its tax rate is 39%. Under the Hamada model, what is LaPorte's estimated cost of equity if the company were to change its capital structure to 50% debt and 50% equity? a. 14.41% 14.89% 15.78% 16.08% b. c. d.Explanation / Answer
Since it is not mentioned which question of the above two to be answered, the question asked first i.e. question no. 14 is answered here:
The correct option is option d. Radley Enterprises has the higher Beta than Scout companies.
Beta shows the volatility of the business i.e the degree of risk and reward of a business as compared to industry average. Since Radley enterprises has the higher fixed costs, its has high degree of risk and reward and thus higher beta than Scout Companies.
The other options given in the question are incorrect due to following reasons:
a. This option is incorrect because Scout companies has lower Beta and hene lower risk.
b. Incorrect because WACC depends upon cost of equity and cost of equity depends upon Beta ( which is not same for both companies )
c. Incorrect because Scout companies can achieve its breakeven by selling only 10,000 units.
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