Question
Straight out of business school, you have been hired as an 10analyst for famed investor and turn-around specialist, Warren Bucket. Mr. Bucket buys underperforming divisions
Straight out of business school, you have been hired as an 10analyst for famed investor and turn-around specialist, Warren Bucket. Mr. Bucket buys underperforming divisions from large conglomerates and restructures them. He has his eye on a division called Berry Fine which makes fizzy fruit drinks. The division is not publicly traded and is completely funded with equity (via retained earnings) by its current parent company. In order to estimate the appropriate discount rate for Berry Fine, you have found
a firm, Mystical Drinks, that is very similar to the division. Mystical, a pure-play, has the following financial characteristics:
Mystical Drinks: Financials (in USD) and Key Ratios
Sales 2.566m
Earnings per share 1.25
Equity beta (E) 2.0
Return on equity (ROE) 20.00%
Price-earnings (PE) ratio: Pt/Et= 9.6
Long-term debt (from balance sheet) 8m Shareholders equity (from balance sheet) 6.25m Shares outstanding 1m Bond rating AAA
Assume the corporate tax rate is zero. If the market risk premium is 8% and treasury bonds are yielding 6%, what is the appropriate discount rate for Berry Fine?
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