BigCo has a market value of $1 billion and a beta of .9. It has three divisions: chemical processing, oil and gas distribution, and plastic products. The company is thinking about buying another chemical producer, ChemCo. ChemCo is expected to earn cash flows of $9 million this year and cash flows are expected to grow 4% per year thereafter. The beta of ChemCo is 1.4. Currently, the risk·free rate is 4% and the expected rate of return on the market portfolio is 11%. (L04)
a. What is the expected rate of return for BigCo?
b. What discount rate should BigCo use to evaluate ChemCo and why?
c. How much is ChemCo worth?
d. Suppose BigCo acquires ChemCo for the price in (c). What will be BigCo's new beta after adding ChemCo?