You have been asked to estimate the beta for a large South Korean company, with
ID: 2718506 • Letter: Y
Question
You have been asked to estimate the beta for a large South Korean company, with large holdings in steel and financial services. You have collected the average betas for global companies in each of the sector, as well as the average debt-to-equity ratios in each sector:
The average tax rate is 70%. In the most recent period the company you are analyzing earned 70% of its operating income from steel and 30% from financial services. It also had a debt-t0 equity ratio of 150% and a tax rate of 30%.
a. Estimate the beta of the company
b. If the Korean government bond rate in USD is 12%, Korean rating is BBB and Korean equities are twice as volatile as Korean bonds, estimate the:
i. Risk-free rate
ii. Market risk premium
iii. Cost of equity for this company valued in USD
Explanation / Answer
Answer-a
From the information given above first we need to calculate the levered beta for both the sectors:
Sector-Steel:
Un-Levered beta = 1.18
Debt equity ratio = 30%
Tax rate = 70%
Therefore,
Levered beta = unlevered beta x(1+(1-tax rate)) x D/E
= 1.18 x(1+(1-0.70) x 30% )
= 1.2862
Sector-Financial services:
Un-Levered beta = 1.14
Debt equity ratio = 70%
Tax rate = 70%
Therefore,
Levered beta = unlevered beta x(1+(1-tax rate)) x D/E
= 1.14 x(1+(1-0.70) x 70%)
= 1.3794
Therefore company levered beta = 70% x 1.2862 + 30% x 1.3794 =1.314
Answer-b
Riskless Rate = Government bond rate - Default spread =12% -2% = 10%
Country risk premium = Default spread * Relative equity market volatility = 2* 2%= 4%
Cost of Equity for the Company =10% + 1.3794 (5.5% + 4%) =23.1043%
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