Corporate finance

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Joined: Sat Apr 30, 2016 9:56 am

Corporate finance

Postby tirtha » Tue Jun 07, 2016 5:41 am

Jay company has a D/E of 2.0. Jay is evaluating the cost of equity for a project in the same line of business as Cass company and will use the pure-play method with Cass as the comparable firm. Cass has a beta of 1.2 and a D/E fof 1.6. The project beta will be most likely:

A) will be less than Jay company's beta
B) will be greater than Jay company's beta
C) could be greater than or less than Jay company's beta.

The answer is C but please help me understand why is the answer C.

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Re: Corporate finance

Postby edupristine » Tue Jun 07, 2016 11:03 am

Hi Tirtha

To calculate the estimated beta of the comparable company

1) First you have to calculate the unlevered beta of the company from the following formula
β unlevered= β levered/(1+(1-tax)D/E)

2) β of company= βunlevered(1+(1-tax)D/E)

In this Question there is no information about taxes, so we can not calculate the jay company beta, so the right answer is C.

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