Working Capital Management, Financial Management

Assignment Help:
The management of Nelson plc wish to estimate their firm’s equity beta. Nelson has had a stock market quotation for only two months and the financial management feels that it would be inappropriate to estimate beta from the actual share price behavior over such a short period. Instead it is proposed to ascertain, and where necessary adjust, the observed equity betas of other companies operating in the same industry, and with the same operating characteristics as Nelson, as these should be based on similar levels of systematic risk and be capable of providing an accurate estimate of Nelson’s beta

Three companies have been identified as firms having operations in the same industry as Nelson with identical operating characteristics. However, only one company, Oak plc, operates exclusively in the same industry as Nelson. The other two companies have some dissimilar activities or opportunities in additional to those which are the same as those of Nelson.

Details of the three companies are as follows;

a. Oak plc has an observed equity beta of 1.12. The capital structure at market value is 60% equity, 40% debt.

b. Beech plc has an observed equity beta of 1.11. It is estimated that 30% of the current market value of Beech is caused by risky growth opportunities which have an estimated beta of 1.9. The growth opportunities are reflected in the observed beta. Beech’s other activities are the same as Nelson’s. Beech is financed entirely by equity.


c. Pine plc has an observed equity beta of 1.14. Pine has two divisions, East and West. East’s operating characteristics are considered to be identical to those of Nelson. The operating characteristics of West are considered to be 50% more risky than those of East. In terms of financial valuation East is estimated as being twice as valuable as west. The capital structure of Pine at market values is 75% equity, 25% debt.

Nelson is financed by equity. The tax rate is 40%.

Required

a. Assuming all debt is virtually risk-free, make three estimate of the equity beta of Nelson plc. The three estimates should be based, separately, on the information provided for Oak, Beech and Pine.

b. Explain why the estimated beta of Nelson, when eventually determined from observed share price movements, may differ from the value derived from the approach in (a) above.

c. State the reason why a company has a very volatile share price and is generally considered to be extremely risky can have a lower beta value, and therefore lower financial risk, than an equally geared firm whose share price is much less volatile.

Related Discussions:- Working Capital Management

The safety margin, Norfolk Ltd is specialized in producing & selling air co...

Norfolk Ltd is specialized in producing & selling air conditions.  In 2010, the manufacturing cost per unit included:

The chinese pension fund system, The Chinese Pension Fund System Mainlan...

The Chinese Pension Fund System Mainland China has a rapidly aging population. This is attributable to two main factors - the one-child policy plus substantial improvements in l

Specialized stock indexes, Specialized Stock Indexes The most regularly...

Specialized Stock Indexes The most regularly quoted market indices are those that include the stocks of the largest listed companies on a nation's largest stock exchange. Examp

Call and notice money, These funds represent borrowings made for a pe...

These funds represent borrowings made for a period of one day to upto a fortnight. However, the mechanism adopted to lend funds to the call and the notice money m

Define a callable bond, What is a callable bond?  What is a putable bond?  ...

What is a callable bond?  What is a putable bond?  How do each of these features affect their respective market interest rates? A callable bond may be retired untimely at the dis

Add or drop analysis, Add or Drop Analysis Lakespring Retirement Village is...

Add or Drop Analysis Lakespring Retirement Village is home to senior citizens who are fairly independent but need assistance with basic health care and occasional meals. Jill Thomp

What are financial centers?, Banks and brokerage firms are measured financi...

Banks and brokerage firms are measured financial centers

Give new marketing strategy, a) B2C businesses provide goods and services t...

a) B2C businesses provide goods and services to the general public, i.e. consumers. HMV sell music, books and DVDs (via Waterstones) to private individuals and can therefore be cla

Ratchet bonds, The coupon rate of these types of bonds is adjusted pe...

The coupon rate of these types of bonds is adjusted periodically at a fixed margin over a reference rate. It can be adjusted southward only and once it is adjuste

What is exit strategy, Exit strategy Venture capitalists and other fina...

Exit strategy Venture capitalists and other financiers will negotiate an exit strategy at the point of advancing the money. The exit strategy will involve them realising their

Write Your Message!

Captcha
Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd