beta, Risk Management

#queThe management of Nelson plc wish to estimate their firm’s equity beta. Nelson has had a stock market quotation for only two months and the financial management feels that it would be inappropriate to estimate beta from the actual share price behavior over such a short period. Instead it is proposed to ascertain, and where necessary adjust, the observed equity betas of other companies operating in the same industry, and with the same operating characteristics as Nelson, as these should be based on similar levels of systematic risk and be capable of providing an accurate estimate of Nelson’s beta

Three companies have been identified as firms having operations in the same industry as Nelson with identical operating characteristics. However, only one company, Oak plc, operates exclusively in the same industry as Nelson. The other two companies have some dissimilar activities or opportunities in additional to those which are the same as those of Nelson.

Details of the three companies are as follows;

a. Oak plc has an observed equity beta of 1.12. The capital structure at market value is 60% equity, 40% debt.

b. Beech plc has an observed equity beta of 1.11. It is estimated that 30% of the current market value of Beech is caused by risky growth opportunities which have an estimated beta of 1.9. The growth opportunities are reflected in the observed beta. Beech’s other activities are the same as Nelson’s. Beech is financed entirely by equity.


c. Pine plc has an observed equity beta of 1.14. Pine has two divisions, East and West. East’s operating characteristics are considered to be identical to those of Nelson. The operating characteristics of West are considered to be 50% more risky than those of East. In terms of financial valuation East is estimated as being twice as valuable as west. The capital structure of Pine at market values is 75% equity, 25% debt.

Nelson is financed by equity. The tax rate is 40%.

Required

a. Assuming all debt is virtually risk-free, make three estimate of the equity beta of Nelson plc. The three estimates should be based, separately, on the information provided for Oak, Beech and Pine.

b. Explain why the estimated beta of Nelson, when eventually determined from observed share price movements, may differ from the value derived from the approach in (a) above.

c. State the reason why a company has a very volatile share price and is generally considered to be extremely risky can have a lower beta value, and therefore lower financial risk, than an equally geared firm whose share price is much less volatile.
Posted Date: 3/27/2013 7:57:15 AM | Location : Kenya
stion..
Posted Date: 4/1/2013 1:26:59 AM | Location : Kenya







Related Discussions:- beta, Assignment Help, Ask Question on beta, Get Answer, Expert's Help, beta Discussions

Write discussion on beta
Your posts are moderated
Related Questions
Problem: (a) What are the two primary stages of Risk Management of a project? (b) What are the formalities to consider in a Project Termination Phase? (c) Briefly explain

AUsing the same situation from SLP 3, recall that you are deciding ... You have heard of an Expert who has a “track record” of high confidence in ... You are now considering whethe

No one thought that the financial system could collapse. It was assumed that sufficient safeguards were in place. Prosperity and stability were evidence that the system worked. Inf

explain LIBOR

Q. Explain about sharpers market model? One important basic development in the portfolio management that led to the development of CAPM was the measurement of risk. The pioneer

What is Industry Risk An industry may be viewed as group of companies which compete with each other to market a homogeneous product. Industry risk is that portion of an  inv

Objectives of risk communication The fundamental goal of risk communication, as you may have realized, is to provide meaningful, relevant and accurate information, in  clear  a

Question: For each of the situations below:- (a) Mention most relevant clause of ISO 27001:2005 (b) Whether the practice followed in the organization is appropriate and i

What are the solution for over trading that has caused for expanding operation

Question: (i). Describe the term ‘ecosystem' (ii). What are the major ecosystems in the tropical marine environment. (iii). State and describe four main ecological/eco