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Q. Estimate the systematic risk of the new investment?
The beta of the comparator company will be utilized to estimate the systematic risk of the new investment. No un-gearing is essential as the asset beta of the comparator company is given. This will require to be regarded to take into account the capital structure of our company.
Beta equity = beta asset*E + D(1- t))/ E
Beta equity = 0·90 *214 + 85(1- 0.3))/ 214= 1.15
Using the capital asset pricing model
ke = Rf + (Rm - Rf) beta = 6% + (14% - 6%) 1·15 = 15·20%
Cost of debt
This remains at 3·60%
Market value of equity $214m
Market value of debt $85m
Weighted average cost of capital
15·20% *214/299+ 3·60% *85/299= 11·90%
The discount rate to be utilized in the investment appraisal when diversifying into the new industry is 11·90%
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