5. [The following table summarizes the percentage changes in operating income, p

Question

5. [The following table summarizes the percentage changes in operating income, percentage changes in revenue and betas for four pharmaceutical firms. %Change in Operating 25% 32% 36% 40% Firm %Change in Revenue SynerCorp 25% BioMed 23% Safemed 21% Beta 1.00 1.15 1.30 1.40 a. Calculate the degree of operating leverage for each of these firms. b. Use the operating leverage to explain why these firms have different betas 6. You are trying to estimate the beta of a private firm that manufactures home appliances. You have managed to obtain betas for publicly traded firms that also manufacture home appliances. The private firm has a debt equity ratio of 25%, and faces a tax rate of 40%. The publicly traded firms all have marginal tax rates of 40%, as well. Firm Black & Decker 140 S 2,500 $ 3,000 Fedders Corp. 20 5 $200 Maytag Corp 20 540 $2250 National Presto 0.70 $8 Whirlpool Beta Debt MV of Equity $ 300 150 $2900 $4000 a. Estimate the beta for the private firm using the bottom-up approach. b. What concerns, if any, would you have about using betas of comparable firms? 7. As the result of stockholder pressure, RJR Nabisco is considering spinning off its food division. You have been asked to estimate the beta for the division, and decide to do so by obtaining the beta of comparable publicly traded firms. The average beta of comparable publicly traded firms is 0.95, and the average debt/equity ratio of these firms is 35%. The division is expected to have a debt ratio of 25%. The marginal corporate tax rate is 36% a. What is the beta for the division? b. Would it make any difference if you knew that RJR Nabisco had a much higher fixed cost structure than the comparable firms used here?

Explanation / Answer

There are too many questions posted and i am solving first one as per chegg policy
5)
a)DOL=% chnage in EBIT/% chnage in Sales
pharmacom=25%/27%=0.93
Syntercorp=32%/25%=1.28
Biomed=36%/23%=1.57
Safemed=40%/21%=1.90

b)beta is the risk associated with the company and it varies for company to company. We can explain this using degree of operating leverage(DOL). If DOL is high means there is more fixed costs and more risk associated with drop in sales . if DOL is high then beta will be high ans we can observe the same

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