Working Capital Management, Financial Management

Assignment Help:
The 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.

Related Discussions:- Working Capital Management

Hedge fund indices, Hedge Fund Indices Substantial increase in the use ...

Hedge Fund Indices Substantial increase in the use of Hedge Funds in recent times has created demand for appropriate indices that can offer a good tool to assess and benchmark

Premium, The amount by which the market price exceeds the conversion ...

The amount by which the market price exceeds the conversion value or the investment value called the premium. When expressed as a percentage, it is given by,

Organization and management of mutual funds, Organization and Management of...

Organization and Management of Mutual Funds: Structural Pattern Mutual Funds, usually formed as trusts, generally involve three parties viz., Settler of the trust or

Weighted-average cost of capital, A Company has the following capital struc...

A Company has the following capital structure: Debt: $2,000,000 Preferred: $1,000,000 Common: $4,000,000 Retained Earnings: $3,000,000 The amounts shown gives book values.  The m

Explain how eurocurrency is created, Explain how Eurocurrency is created. ...

Explain how Eurocurrency is created. Answer: The center of the international money market is the Eurocurrency market. A Eurocurrency is a time deposit of money in an internationa

Selection of a project in financial management, Q. Selection of a project i...

Q. Selection of a project in Financial Management ? The selection of a project is typically made on the following line: (i) In general a project becomes acceptable if it has

Cyclical variation in time series analysis, Cyclical Variation By cycli...

Cyclical Variation By cyclical variations, we refer to the long-term movement of the variable about the trend line. Therefore, does the movement of the actual series about a tr

Downgrade risk, Market participants' measure the default risk of an i...

Market participants' measure the default risk of an issue on the basis of the credit ratings that the credit rating agencies assign to the issues. Once rating is

What is translation risk, Q. What is Translation risk? This risk occurs...

Q. What is Translation risk? This risk occurs on consolidation of financial statements prior to reporting financial results and for this reason is as well known as accounting e

Cost of equity from new common stock, Weaver Chocolate Co. expects to gain ...

Weaver Chocolate Co. expects to gain $3.50 per share during the present year, its expected dividend payout ratio is 65%, its expected constant dividend growth rate is 6.0%, and its

Write Your Message!

Captcha
Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd