Estimate the beta of an unlevered firm

Assignment Help Finance Basics

Reference no: EM131951123

Question: Business and Financial Risk-MM Model Air Tampa has just been incorporated, and its board of directors is currently grappling with the question of optimal capital structure. The company plans to offer commuter air services between Tampa and smaller surrounding cities. Jaxair has been around for a few years, and it has about the same basic business risk as Air Tampa would have. Jaxair's market-determined beta is 1.8, and it has a current market value debt ratio (total debt to total assets) of 45% and a federal-plus-state tax rate of 40%. Air Tampa expects to be only marginally profitable at start-up; hence its tax rate would only be 25%. Air Tampa's owners expect that the total book and market value of the firm's stock, if it uses zero debt, would be $13 million. Air Tampa's CFO believes that the MM and Hamada formulas for the value of a levered firm and the levered firm's cost of capital should be used. (These are given in equations VL = VU + VTax shield = VU + TD, rsL = rsU + (rsU - rd)(1 - T)(D/S), and b = bU[1 + (1 - T)(D/S)].)

a. Estimate the beta of an unlevered firm in the commuter airline business based on Jaxair's market-determined beta. (Hint: This is a levered beta; use Equation b = bU[1 + (1 - T)(D/S)] and solve for bU.) Do not round intermediate calculations. Round your answer to three decimal places.

b. Now assume that rd = rRF = 9% and that the market risk premium RPM = 7%. Find the required rate of return on equity for an unlevered commuter airline. Do not round intermediate calculations. Round your answer to three decimal places. %

c. Air Tampa is considering three capital structures:

(1) $3 million debt, (2) $5 million debt, and (3) $8 million debt. Estimate Air Tampa's rs for these debt levels. Do not round intermediate calculations. Round your answers to two decimal places

1. Air Tampa's rs for $3 million debt is %.

2. Air Tampa's rs for $5 million debt is %.

3. Air Tampa's rs for $8 million debt is %.

d. Calculate Air Tampa's rs at $8 million debt while assuming its federal-plus-state tax rate is now 40%. (Hint: The increase in the tax rate causes VU to drop to $11 million.) Do not round intermediate calculations. Round your answer to two decimal places. %

Reference no: EM131951123

Questions Cloud

Calculate the company collection float : Calculate the company's disbursement float, collection float, and net float. (A negative answer should be indicated by a minus sign.

Diversity or wellness program : Workforce Diversity and Wellness- What are your thoughts on your current organizations attempt at a diversity or wellness program?

Evaluate a fictional foundations investment strategy : SIP60004 - Social Investment and Philanthropy Assessments. This assessment task requires that you evaluate a fictional foundation's investment strategy

Strategic decision makers of the firm polaris-victory : Identify and list in order of criticality the key issues facing strategic decision makers of the firm Polaris & Victory

Estimate the beta of an unlevered firm : Estimate the beta of an unlevered firm in the commuter airline business based on Jaxair's market-determined beta.

Write code that will delete the node after the node pointed : Write code that will delete the node after the node pointed to by p2. After this code is executed, the linked list should be the same.

Competitive advantage in attracting major industry : Does the Gainesville/Alachua County area have a Sustainable Competitive Advantage in attracting major industry and/or major distribution facilities to the area?

Managing a large-scale corporate project : Describe a project you implemented. You may use any project- potty training your child or managing a large-scale corporate project.

Discuss the organisms in the domains bacteria and archaea : Discuss the similarities and differences between organisms in the domains Bacteria and Archaea.

User Account

All Pages