You were appointed the CFO of a firm with 2 divisions: Div. 1 -- produces regular...

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Finance

You were appointed the CFO of a firm with 2 divisions:
Div. 1 -- produces regular telephones
Div. 2 -- produces specialty micro-chips which areused in cell phones
Given Information:
Market value of your firm’s debt = $100million
Market value of your firm’s equity = $100million
Overall/total value of firm = $200 million.
Beta of firms’ equity = 2
Firm’s debt = riskless.
Expected excess return on themarket over the riskless rate = 8% percent
Risk-free rate = 2%
Assume that the CAPM holds.
Engineers in Division 2 now discover an opportunity to invest ina new production technology which would enable it to produce bettermicro-chips. The required investment would be $15 million today(t=0), but the investment would increase expected Division 2 salesrevenues by $4 million per year (each year, indefinitely, startingat t=1). You should assume that the systematic risk (the assetbeta) of Division 2 will be unaffected by the switch to the newproduction technology.
Question 1: What is the asset beta for Division2?
Question 2: Would you recommend that your firminvests in the new production technology?
Question 3: Suppose your firm announces at t=0that it will invest in the new production technology and issues $15million worth of debt to finance the upfront investment.
If there are 10 million shares outstanding, what will the price pershare be right after this has been done (i.e. right after t=0)?

Answer & Explanation Solved by verified expert

4.2 Ratings (986 Votes)

1 Asset beta for the company equity betaEV debt betaDV where EV equity to total value ratio 05 and DV debt to total value 05 Asset beta 205 005 1 Asset beta for the company Asset beta See Answer

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You were appointed the CFO of a firm with 2 divisions:Div. 1 -- produces regular telephonesDiv. 2 -- produces specialty micro-chips which areused in cell phonesGiven Information:Market value of your firm’s debt = $100millionMarket value of your firm’s equity = $100millionOverall/total value of firm = $200 million.Beta of firms’ equity = 2Firm’s debt = riskless.Expected excess return on themarket over the riskless rate = 8% percentRisk-free rate = 2%Assume that the CAPM holds.Engineers in Division 2 now discover an opportunity to invest ina new production technology which would enable it to produce bettermicro-chips. The required investment would be $15 million today(t=0), but the investment would increase expected Division 2 salesrevenues by $4 million per year (each year, indefinitely, startingat t=1). You should assume that the systematic risk (the assetbeta) of Division 2 will be unaffected by the switch to the newproduction technology.Question 1: What is the asset beta for Division2?Question 2: Would you recommend that your firminvests in the new production technology?Question 3: Suppose your firm announces at t=0that it will invest in the new production technology and issues $15million worth of debt to finance the upfront investment.If there are 10 million shares outstanding, what will the price pershare be right after this has been done (i.e. right after t=0)?