Computation of beta and asset beta

Reference no: EM1316736

The following table lists possible rates of return on Compton Technology\'s stock and debt and on the market portfolio. The probability of each state is also listed.

a. What is the beta of Compton Technology debt?

b. What is the beta of Compton Technology stock?

c. If the debt-to-equity ratio of Compton Technology is 0.5, what is the asset beta of Compton Technology? Assume no taxes.

		Return on	Return on	Return on the
State	Probability	Stock (%)	Debt (%)	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

Note: First, calculate the expected return on Compton's stock. Then, calculate the expected return on Compton's debt. Calculate the expected return on the market. Calculate the covariance of the stock's return with the market's return. Calculate the covariance of the debt's return with the market's return. Calculate the market variance.

Part a: Calculate the beta of Compton Technology's debt by dividing the covariance of the debt's return with the market's return by the variance of the market.

Part b: Calculate the beta of Compton Technology's stock by dividing the covariance of the stock's return with the market's return by the variance of the market.

Part c: Calculate the equity to value ratio [S / (S+B)] and the debt to value ratio [B / (S+B)] by substitution. When there are no taxes, the asset beta is equal to the weighted average of the stock beta and the debt beta. Let me know if any question.

Reference no: EM1316736

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