Q. Estimate the systematic risk of the new investment?
The beta of the comparator company will be utilized to estimate the systematic risk of the new investment. No un-gearing is essential as the asset beta of the comparator company is given. This will require to be regarded to take into account the capital structure of our company.
Re-gearing
Beta equity = beta asset*E + D(1- t))/ E
Beta equity = 0·90 *214 + 85(1- 0.3))/ 214= 1.15
Using the capital asset pricing model
ke = Rf + (Rm - Rf) beta = 6% + (14% - 6%) 1·15 = 15·20%
Cost of debt
This remains at 3·60%
Market value of equity $214m
Market value of debt $85m
Weighted average cost of capital
15·20% *214/299+ 3·60% *85/299= 11·90%
The discount rate to be utilized in the investment appraisal when diversifying into the new industry is 11·90%