Assume that Expansion Ltd is a diversified company that is considering an expansion project in a mining division.The company has a target debt-equity ratio of 1:2 and this ratio will not be affected by the new project.The company's manager has identified Dig-it-out Ltd as a company with the same business risk as the new project (equity beta of 1.5).Dig-it-out has a debt-equity ratio of 1:3.What is the beta estimate of Expansion Ltd?
A)1.69
B)1.12
C)1.5
D)1.75

Question

Quizplus · Accepted Answer

1. Calculate the unlevered beta of Dig-it-out Ltd using the debt-equity ratio:
Unlevered beta = Equity beta / (1 + (1 - tax rate) * Debt/Equity)
Unlevered beta = 1.5 / (1 + (1-0.3) * 1/3) = 1.2

2. Calculate the beta estimate of Expansion Ltd using the unlevered beta and target debt-equity ratio:
Beta estimate = Unlevered beta * (1 + (1 - tax rate) * Debt/Equity)
Beta estimate = 1.2 * (1 + (1-0.3) * 1/2) = 1.69

Therefore, the answer is A) 1.69.

Assume That Expansion Ltd Is a Diversified Company That Is