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i know the difference between asset beta & equity beta
but i read a term in question ‘overall beta’, what is this?please refer to point (v) of the below question
the question goes like:
NS Technologies Limited is in the business of developing financial software. The
directors of the company believe that the scope of future growth in the software sector is
limited and are considering to diversify into other activities. An option available with
the company is to sign an eight year distribution contract with a leading manufacturer of
telecommunication equipments.
Some of the important information related to the above proposal is as follows:
(i) Total investment is estimated at Rs. 600 million. It includes developing the
necessary infrastructure, purchase of equipment and working capital
requirements.
(ii) The investment is expected to generate pre-tax net cash flows of Rs. 180 million
per year.
(iii) Presently NS is paying interest @ 9% on its long term debt.
(iv) NS maintains a debt equity ratio of 55:45 whereas its equity beta is 0.9.
(v) Average debt ratio, OVERALL BETA and debt beta of telecommunication equipment
distribution segment is 40%, 1.5 and 1.3 respectively.
(vi) The market rate of return is 14% whereas yield on one year treasury bills is 6%.
(vii) Costs associated with the issuance of debt and equity instruments are estimated
at 1% and 3% respectively.
(viii) Tax rate applicable to the company is 35%. Tax is paid in the same year as the
income to which it relates.
(ix) In case the contract is not renewed upon expiry, after tax cash flows of Rs. 90
million would be generated from disposal of allied resources.Required:
Evaluate the above proposal using the APV method.Thanks
There is no such standard term as the “overall beta” and it certainly has never been used in the exam (this is not a past exam question) and will not be used (unless it is explained within the question what it is meant to represent).
I can only guess that whoever wrote this question intends for it to mean the average of the equity beta and the debt beta. Although that would give you an (easy) bit of extra arithmetic to do in order to calculate the equity beta, it would be meaningless in real life (especially since it is referring to the betas of the sector).
I think that I would as well (but as I wrote, whoever created the question should not have used the term ‘overall beta’ without explaining what they meant by it).
what would u say for this question?
(in this qs it is treated as a beta equity)please see in capital words: AVERAGE BETA
part of qs & solution is reproduced below:
38 Mercury Training (6/08, amended) 45 mins
Mercury Training was established in 1999 and since that time it has developed rapidly. The directors are
considering either a flotation or an outright sale of the company.
The company provides training for companies in the computer and telecommunications sectors. It offers a variety
of courses ranging from short intensive courses in office software to high level risk management courses using
advanced modelling techniques. Mercury employs a number of in-house experts who provide technical materials
and other support for the teams that service individual client requirements. In recent years, Mercury has diversified
into the financial services sector and now also provides computer simulation systems to companies for valuing
acquisitions. This business now accounts for one third of the company’s total revenue.
Mercury currently has 10 million, 50c shares in issue. Jupiter is one of the few competitors in Mercury’s line of
business. However, Jupiter is only involved in the training business. Jupiter is listed on a small company
investment market and has an estimated beta of 1.5. Jupiter has 50 million shares in issue with a market price of
580c. The AVERAGE BETA for the financial services sector is 0.9. Average market gearing (debt to total market value)
in the financial services sector is estimated at 25%.
Other summary statistics for both companies for the year ended 31 December 2007 are as follows:
Mercury Jupiter
Net assets at book value ($million) 65 45
Earnings per share (c) 100 50
Dividend per share (c) 25 25
Gearing (debt to total market value) 30% 12%
Five year historic earnings growth (annual) 12% 8%
Analysts forecast revenue growth in the training side of Mercury’s business to be 6% per annum, but the financial
services sector is expected to grow at just 4%.
Background information:
The equity risk premium is 3.5% and the rate of return on short-dated government stock is 4·5%.
Both companies can raise debt at 2.5% above the risk free rate.
Tax on corporate profits is 40%.
Required
(a) Estimate the cost of equity capital and the weighted average cost of capital for Mercury Training. (8 marks)Solution:
(a) Step 1
Ungear beta of Jupiter and Financial Services sector
?a = ?g e
e d
V
V ? V (1- T)
Jupiter = 1.5 ×88 / {(12x 0.6) +88}
? ?
= 1.3865
FS sector = 0.9 ×75/ {(25x 0.6) +75}
? ?
= 0.75
Step 2
Calculate average asset beta for Mercury
?a = (0.67 × 1.3865) + (0.33 × 0.75) = 1.175Average beta does not mean ‘overall beta (which means nothing)’ and here there is no dispute.
As I explain in the lectures, the betas that are published in the papers are always equity betas, and therefore if ever you are given a beta it is an equity beta unless you are told differently.
The reason they call it the average beta here is that it is the average for the sector – i.e. the average of all equity betas of companies in that sector.
(PS There is no need to type out a whole question like this – it is an old exam question and I can therefore look at it myself without you needing to spend time typing 🙂 )
Thats OK then (I was thinking you had spent all day typing it out 🙂 )
Glad it helped anyway 🙂
could u also plz guide over time management issue in the paper
this is not my first attempt
so im quite confident about my preparation
but really worried about the time management issue which affected me previouslyYou have 3 hours for 100 marks and so you should allow 1.8 minutes per mark.
So, if (for example) part (a) of Question 1 is 15 marks, then you should allow 15 x 1.8 = 27 minutes for this part.
That will likely mean that you will not have finished part (a) but still carry on with part (b) (start a new page, so that if you have time later then you can come back and do more on part (a)).
It is better to hand in every part of every question even if they are all only part finished, then to finish just some questions (and probably have made mistakes anyway) and not attempt some at all.
Remember that you need 50% to pass. You should be aiming to get at least 50% on every part of every question. Once you have got the 50%, then every extra thing you do is almost a bonus 🙂
There is rarely a situation where you need the answer from part (a) of question to be able to continue with part (b) of the question.
If you do need (for an example) an NPV calculated in part (a) to be able to comment on in part (b), then if you have not finished part (a) and therefore do not have an NPV, then invent one!! (Say that you have invented it). Discussing your ‘invented’ NPV correctly will get full marks for part (b) even though it was not the correct NPV.
Could you please help solve this Qs
query: 1) confusion as to how to incorporate growth & inflation both?
2) this question is about cashflows growing & inflating in perpetuity what about if we are given ‘x’ no. of years of project life(GL) operates a chain of large retail stores in country X where the functional
currency is CX. The company is considering to expand its business by establishing similar retail
stores in country Y where functional currency is CY. As a policy, GL evaluates all investments
using nominal cash flows and a nominal discount rate.
The required investments and the estimated cash flows are as follows:
(i) Investment in country X
CX 7 million would be required to establish warehouse facilities which would stock
inventories for supply to the retail stores in country Y at cost. At current prices, the annual
expenditure on these facilities would amount to CX 0.5 million in Year 1 and would grow
@ 5% per annum in perpetuity.
Investment in country Y
Investment of CY 800 million would be made for establishing retail stores in country Y.
At current prices, the net cash inflows for the first three years would be CY 170 million,
250 million and 290 million respectively. After Year 3, the net cash inflows would grow at
the rate of 5% per annum, in perpetuity.
(ii) Inflation in country X and Y is 7% and 20% per annum respectively and are likely to remain
the same, in the foreseeable future. Presently, country Y is experiencing economic difficulties
and consequently GL may face problems like increase in local taxes and imposition of
exchange controls.
(iii) The current exchange rate is CX 1 = CY 45.
(iv) GL’s shareholders expect a return of 22% on their investments. GL uses this rate to evaluate
all its investment decisions.thanks
I am really sorry but I am answering 100’s of questions a day at the moment and I do not have time to provide answers to full questions.
You surely have an answer in the same book that you found the question and so you must ask which specific bits are causing problems.
To discount an inflating perpetuity you use the dividend valuation formula (it gives the present value for any growing perpetuity).
If it is only for a specific number of years, you either inflate the flows year by year and discount each year separately.
Or (if all flows are inflating at the same rate) then you discount the current price flows (without inflation) at the real cost of capital (without inflation).
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