# Cost of Capital - Asset's Beta

Hi,

Can you please help with this problem? Where did ßasset of 0.911 come from in the answer explanation?

Shawn Miller, CFA, is a buy-side analyst for a foundation managing a global large-cap fund. He has hired the services of a telecommunications industry expert, Phillipa Jenkens. Miller is analyzing one of the fund’s largest holdings, a mobile phone manufacturer Satellite QS operating globally in 50 countries with historical global revenues of $12.4 billion. Recently, Satellite’s management announced expansion plans for a greenfield investment in Indonesia. Miller is concerned about the implications of the expansion plans on Satellite’s risk profile and is wondering whether he should issue a ‘sell’ recommendation on the fund holding. Miller provides Jenkens with basic company information. Satellite’s global annual free cash flow to the firm is$700 million, which is expected to level off at a 3.5 percent growth rate and earnings are $550 million. Miller estimates that Satellite’s after-tax free cash flows to the firm on the Indonesia project for the next four years are$60 million, $64 million,$67.5 million and $70.4 million. The company has just recently announced a dividend of$2.5 per share of stock. To keep the analysis simple, Miller asks Jenkens to ignore any possible exchange rate fluctuations. For the first four years, the Indonesian plant is expected to serve Indonesian customers only. Jenkens has been assigned to evaluate Satellite’s financing plans of $130 million with a$97.50 million public offering of 8-year debt in the US and the remainder to be financed by means of equity offering.

Additional information:

Equity risk premium, US 3.20 percent

Risk-free rate of interest, US 1.50 percent

Industry debt-to-equity ratio 0.45

Market value of Satellite’s debt $750 million Market value of Satellite’s equity$3.2 billion

Satellite’s equity beta 1.05

Satellite’s before-tax cost of debt 5.25 percent

Indonesia credit A2 country risk premium 4.58 percent

Corporate tax rate 35 percent

Interest payments each year Level

Miller wants to conduct sensitivity analysis for the effect of the new project on the company’s cost of capital. The estimated project beta for Indonesia project if it is financed with 75% with debt and has the same asset risk as Satellite, is closest to:
A 3.841.
B 2.699.
C 2.688.

Explanation:

C is correct. Project beta = βasset * [1 + (1 - t)D/E] = 0.911 [1 + [(1 – 0.35) ($97.5 /$32.5)]] = 0.911 (2.96) = 2.688.

\frac{Equity \ beta}{1+(1-Tax \ rate) \frac{Debt}{Equity}} = \frac{1.05}{1+(1-0.35)\frac{750m}{3200m}}

thank you so much! I figured from your equation that I was supposed to calculate βasset!

1 Like

Yes. That’s the formula for the asset beta.