North Pole Fishing Equipment Corporation and South Pole Fishing Equipment Corpor
ID: 2782964 • Letter: N
Question
North Pole Fishing Equipment Corporation and South Pole Fishing Equipment Corporation would have identical equity betas of 1.23 if both were all equity financed. The market value information for each company is shown here:
The expected return on the market portfolio is 12.2 percent, and the risk-free rate is 4.5 percent. Both companies are subject to a corporate tax rate of 40 percent. Assume the beta of debt is zero.
What is the equity beta of each of the two companies? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)
What is the required rate of return on each of the two companies’ equity? (Do not round intermediate calculations and enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.)
North Pole Fishing Equipment Corporation and South Pole Fishing Equipment Corporation would have identical equity betas of 1.23 if both were all equity financed. The market value information for each company is shown here:
Explanation / Answer
Equity beta of each of the two companies
north pole = 0.69
South Pole = 0.54
Calculations
North Pole equity beta = Debt( Beta of debt) + Equity ( Beta of equity)/ Debt + Equity
30,30,000(0) + 39,30,000(1.23)/ 30,30,000 + 39,30,000
= 0 + 48,33,900/ 69,60,000
=0.69
South Pole equity beta = Debt( Beta of debt) + Equity ( Beta of equity)/ Debt + Equity
= 39,30,000(0) + 30,30,000(1.23)/ 69,60,000
=0.54
B. what is the required rate of return of the two companies' equity
North pole = 9.81
south pole = 8.66
Calculation
as per capital asset pricing model required rete of return = Rf + B(Rm-Rf)
where Rf = risk free return = 4.5%
B = beta of stock = 0.69/0.54
Rm= Rate of return on market = 12.2%
North pole required rate of return = 4.5 + (12.2 - 4.5) 0.69 = 4.5 + 5.31 = 9.81
South pole required rate of return = 4.5 + (12,2 - 4.5) 0.54 = 4.5 + 4.16 = 8.66
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