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ABC is a holding company with four main subsidiaries. The percentage of its business coming from each of the subsidiaries, and their respective betas, are as follows:
Subsidiary Percentage of Business Beta
R 40% 0.5
S 35% 0.8
T 15% 1.1
U 10% 1.4
Question a. What is the holding company's beta?
Question b. Assume the risk-free rate is 4% and that the market risk premium is 3%. What is the holding company's required rate of return?
Question c. ABC is considering a change in its strategic focus: It will reduce its reliance on R so that the percentage of its business from this subsidiary will be 30%. At the same time, ABC will increase its reliance on U, and the percentage of its business from that subsidiary will rise to 20%. What will be the shareholders' required rate of return if management adopts these changes? What will be the shareholders' required rate of return if management adopts these changes and expected inflation is expected to increase by 1% due to the current economic condition?
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