A Case Report. Generex Company is considering expanding into the growing area of

Question

A Case Report.
Generex Company is considering expanding into the growing area of bacterial cloning. Generex’s current beta is 1.30. The beta is expected to increase to 1.50 after expansion. The long term growth rate is expected to increase from 3 percent before expansion to 6 percent after expansion. Generex currently (year 0) pays a dividend of $1.50 per share. The current risk-free rate is 7 percent. The historical (and projected) market risk is 8.6 percent. If the goal of the Generex is to maximize shareholder wealth should it undertake the expansion?
You have to work out the problem quantitatively to say why.
Q2.
Determine the beta of a portfolio consisting of equal investments in the following common stocks:

Security Beta
A T & T .90
Bank of America 1.10
Chrysler 1.40
Wal-Mart Stores 1.25
Thanks for your help

Explanation / Answer

Q1 Assume Generex is all equity firm (no debt) -> cost of capital = cost of equity
Before expansion

cost of equity = risk free rate + Beta*market risk = 7+1.3*8.6 = 18.18%

Therefore, discount rate, d = 18.18% and growth rate, g=3%

current price of its stock = Dividend / (d-g) = 1.5/(0.1818-0.03) = $9.88 per share

After expansion

cost of equity = risk free rate + Beta*market risk = 7+1.5*8.6 = 19.9%

Therefore, discount rate, d = 19.9% and growth rate, g=6%

current price of its stock = Dividend / (d-g) = 1.5/(0.199-0.06) = $10.79 per share

If the firm wants to maximize shareholder wealth, it should undertake the expansion since it will increase stock price (and thus shareholder wealth) from $9.88 to $10.79 a share

Q2

Overall beta = (0.9+1.1+1.4+1.25)/4 = 1.1625

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