Nielsen Motors (KM) is a newly public firm with 25 million shares outstanding. Y

Question

Nielsen Motors (KM) is a newly public firm with 25 million shares outstanding. You arc doing a valuation analysis of Nielson and you estimate its free cash flow in the coming year to be WO million. You expect the firm's free cash flows to grow by 4% per year in subsequent years. Because the firm has only been listed on the stock exchange for a short time, you do not have an accurate assessment of Nielson's equity beta. However, you do have the following data for another firm in the same industry: Nielson has a much lower debt equity ratio of .5. which is expected to remain stable, and Nielson's debt is risk free. Nielson's corporate tax rate is 40%, the risk - free rate is 5%, and the expected return on the market portfolio is 10%. Nielson's estimated equity beta is closest to: 0.95 1.25 1.45 1.00

Explanation / Answer

Levered Equity Beta = 1.80

Debt Equity ratio = 1.5

Tax rate = 40%

Unlevered Equity beta of company is calculated below using following formula:’

Unlevered beta = (beta levered) / 1 + (1 - tax rate) x (Debt/Equity)

                           = 1.80 / [1+ (1 – 40%) × (1.5)]

                           = 1.80 / [1+ 0.9]

                           = 0.95

Unlevered beta is 0.95 or equity beta of company is 0.95 hence, Option (A) is correct answer.

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