Schroeder Electronics (Schroeder) is evaluating a new investment Project X, which is totally unrelated to its existing
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Question:
Schroeder Electronics (Schroeder) is evaluating a new investment Project X, which is totally unrelated to its existing line of business. However, it has identified a publicly traded comparable firm ZES that is exclusively engaged in the same line of business as Project X. Additional information for ZES are given in the table below.
Debt outstanding (book value, AA- rated) | $ 50 million |
Number of shares outstanding | 50 million |
Stock price per share | $10 |
Book value of Equity per share | $7 |
Beta of equity | 1.4 |
Assume that Schroeder has a debt to equity ratio of 0.4 and a marginal tax rate of 28%. The current yield of Schroeders long term debt is 4.5%. The risk-free rate is 3% and the market risk premium is 5%.
- Assume a debt beta of zero and estimate ZESs asset beta using the information above.
- Explain how debt features affect the beta of debt. When is it more suitable to assume that debt has a zero beta? (Please type your answer in no more than 50 words)
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