The following table lists possible rates of return on Compton Technology’s stock and debt and on the market portfolio. The probabilityof each state is also listed.
State Probability Return on Stock (%) Return on Debt (%) Return on the Market (%)
1 0.1 3% 8% 5%
2 0.3 8 8 10
3 0.4 20 10 15
4 0.2 15 10 20
1. What is the beta of Compton Technology debt?
2. What is the beta of Compton Technology stock?
3. If the debt-to-equity ratio of Compton Technology is 0.5, what is the asset beta of Compton Technology? Assume no taxes.
The large Brewing Corporation has acquired the Philadelphia Pretzel Company in a vertical merger. Lager Brewing has issued $300,000 in new Long-term debt to pay for its purchase. ($300,000) is the purchase price.) Construct the balance sheet for the new corporation if the merger is treated as a purchase for accounting purposes. The balance sheets shown here represent the assets of both firms at their true market values. Assume these market values are also the book values.
LAGER BREWING CORPORATION
(in $ thousands)
Current assets $400 Current liabilities $200
Other assets 100 Long-term debt 100
Net fixed assets 500 Equity 700
Total ———— —————–
PHILADELPHIA PRETZEL COMPANY
(in $ thousands
Current assets $80 Current liabilities $80
Other assets 40 Eqity 120
Net fixed assets 80
total ———– total ———
Suppose the balance sheet for Philadelphia Pretzel in problem 29.1 shows the assets at their book value and not their market value of $240,000. Construct the balance sheet for the new corporation. Again, treat the transaction as a purchase.
Refer to the Global Resources example in section 29.8 of the text. Suppose that instead of 40 shares, Global exchanges 100 of its shares for the 100 shares of Regional. The new Global Resources will now have 200 shares outstanding and earnings of $200. Assume the market is smart.
1. Calculate Global’s value after the merger.
2. Calculate Global’s earnings per share.
3. Calculate Global’s price per share.
4. Redo your answers to (a), (b), and (c) if the market is fooled.
Debt and Asset Beta, Debt-to-Equity Ratio, Balance Sheets and Market Value are investigated.