Explore BrainMass

Explore BrainMass

    Equity beta and rate of return

    This content was COPIED from BrainMass.com - View the original, and get the already-completed solution here!

    North Pole Fishing Equipment Corporation and South Pole Fishing Equipment Corporation would have identical equity betas of 1.2 if both of them were all-equity financed. The capital structures of the two firms are as follows:

    North Pole South Pole
    Debt $1,000,000 $1,500,000
    Equity $1,500,000 $1,000,000

    The expected return on the market portfolio is 12.75 percent, and the risk-free rate is 4.25 percent. Both firms are subject to a corporate tax rate of 35 percent. Assume the debt beta of each of the two firms equals 0.

    1. What is the equity beta of each of the two firms?
    2. What is the required rate of return on each of the two firm's equity?

    © BrainMass Inc. brainmass.com June 3, 2020, 7:02 pm ad1c9bdddf

    Solution Preview

    a. The equity beta of a firm financed entirely by equity is equal to its unlevered beta.

    Find each of the firm's equity betas, given an unlevered beta of 1.2.

    North Pole

    βEquity = [1 + (1-TC)(B/S)]βUnlevered

    where βEquity = the equity beta
    βUnlevered = the unlevered beta
    TC = the corporate tax rate
    B = the value of the firm's debt
    S = the value of the firm's equity

    In this problem:

    Unlevered = ...

    Solution Summary

    The solution explains how to calculate the equity beta and the required rate of return.