Reference no: EM132928651

Question - Umbrella Inc. is publicly traded company with 500m shares outstanding, trading at $21/share. The book value of equity in the company is 5 billion and the expected net income next year is $800m. You have run a regression of price to book ratios for companies in the same sector against return on equity and leverage and arrived at the following: price to book equity=0.30+8 return on equity+0.95(book equity/(book equity+ book debt)).

(All percentages are entered as decimals in the regression. Thus 15% return on equity would be entered as 0.15).

a) If you believe that Umbrella Inc. is correctly priced relative to other firms in the sector, what is the book value of the debt in the company?

b) Umbrella Inc. expects to sell off one of its divisions, which has expected net income of $300m next year and a current book value of equity of $3 billion. It expects to be able to sell the division at book value and pay the cash ($3 billion) out as dividends. i) estimate the price per share after the sale. ii) would your answer be different if the company used the $3 billion to pay down its debt. iii) Assume price to book equity ratio remains unchanged at 2.1.