Investment theory:

(Assume no corporate taxes unless noted otherwise)

Firm CDI Inc. has the following capital structure:

a. What is the firms asset beta? (Recall: the beta of a portfolio is a weighted average of the underlying betas)

b. Assume the CAPM holds. What discount rate should CDI Inc. use for projects similar to its current projects? The risk-free rate is 5% and the expected return on the market is 13%.

c. CDI Inc. decides to issue an additional $100 million of equity and uses the cash to repurchase all its debt. How does the firms asset beta change? How does its equity beta change? Explain your answer.

Beta Market Value (in $millions) 100 Debt Equity O 1.2 200