Estimate the systematic risk of the new investment, Financial Accounting

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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.

Re-gearing

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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