The CFO described in Problem 13.35 asks you to estimate the beta for Coral Gables common stock.
Question:
The CFO described in Problem 13.35 asks you to estimate the beta for Coral Gables’ common stock. Since the common stock is not publicly traded, you do not have the data necessary to estimate the beta using regression analysis. However, you have found a company with publicly traded stock that has operations exactly like those at Coral Gables. Using stock returns for this pure-play comparable firm, you estimate the beta for the comparable company’s stock to be 1.06.
The market value of that company’s common equity is $45 million, and it has one debt issue outstanding with a market value of $15 million and an annual pretax cost of 4.85 percent. The comparable company has no preferred stock.
a. If the risk-free rate today is 4.25 percent and the market risk premium is 6.00 percent, what is the beta of the assets of the comparable company?
b. If the total market value of Coral Gables’ financing consists of 35 percent debt and 65 percent equity (this is what the CFO estimates the market values to be) and the pretax cost of its debt is 5.45 percent, what is the beta for Coral Gables’
common stock?
Step by Step Answer:
Fundamentals Of Corporate Finance
ISBN: 9781119795438
5th Edition
Authors: Robert Parrino, David S. Kidwell, Thomas W. Bates