(^284) Financial Management
be = ba
$
$
...(36)Illustration 2: Nicole Publishing Companysí market value of shares and debt is Rs
50 crore and Rs 15 crore respectively. The beta of the companyís share is 1.32. The
expected corporate tax rate for the company is 35 percent. Calculate Nicoleís asset
beta.
Total value of the firm, V = 50 + 15 = Rs 65 crore
Value of shares, S = Rs 50 crore
Value of debt, L) = Rs 15 crore
Debt ratio, D/V = L = 15/65 = 0.23
ba =
%%
$ $ = =- ¥
= -b -It is not difficult to appreciate that for an unlevered firm (a firm without any debt), the
asset and equity bet will be the same. For a levered firm, the cost of equity under
CAPM will be as follows:
ke = rf 3- (rm - rf) be ...(37)
= rf + (rm - rf)ba ...(38)
where ba is the asset beta of an unlevered firm.
Illustration 3: Chemicals has an equity beta of 1.25 and debt ratio of 0.5. The risk-
free rate is 9 per cent and the expected market rate of return is 20 per cent. The
corporate tax rate is 35 percent. What is Desai chemicalís required rate of return on
equity?
If we use Equation (37), we obtain:
ke = 0.09 + (0.20 - 0.09)1.25 = 0.09 + 0.1375 = 0.2475 or 24.75%
The asset beta is:ba =
$ $ = =- ¥
= -b -Using Equation (37), we obtain:ke = 0.09 + (0.20 - 0.09)0.758
- ¥
= 0.09 + (0.20 ñ 0.09)0.758 ◊ 1.65= 0.09 + (0.20-0.09)1.25 = 0.2475 or 24.75%