Question
The following are the betas of the equity of four forestry/paper product companies, and their debt/equity ratios. Assume all firms face a corporate tax rate
The following are the betas of the equity of four forestry/paper product companies, and their debt/equity ratios. Assume all firms face a corporate tax rate of 40%. Also assume that all firms target to keep their debt/equity ratio constant, and that their debt is risk-free, i.e., debt beta is zero. [All parts together: 6 points]
Company Equity Beta Debt/Equity Ratio
Weyerhaeuser 1.15 33.91%
Champion International 1.18 54.14%
International Paper 1.05 45.50%
Kimberly-Clark 0.91 11.29%
1. Estimate the unlevered beta of each firm. What do unlevered betas tell you about these firms? Show your calculations.
2. Assume now that Kimberly-Clark is planning to increase its debt/equity ratio to 30%. What will its new equity beta be? Show your calculations.
3. If you were valuing an initial public offering in the paper products area, what beta would you use in the valuation? Assume that the firm going public has a debt/equity ratio of 40%. Show your calculations.
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