Beta Factor and Rate Returns

The remainder of this note discusses each of the steps in the process and then provides an exercise on the various financial measures that are useful as part of the analysis. The final section of the note demonstrates the relationship between a firm’s strategy and operating characteristics; and its financial characteristics.

We are interested in obtaining the asset beta for Collinsville investment. Here from the reading material, we find there were altogether 6 chemical companies that produce sodium chlorates. They are Hooker, Pennwalt, American, Kerr-McGee, Brunswick and Southern. However, since we are evaluating the addition of a sodium chlorate plant, the two firms (Brunswick and Southern) who specialize in producing sodium chlorate are likely the best “twins”. To determine the asset betas of each company, we

The table below shows the equity betas for the firms presented in the case (using Jan-92 to Dec-96 equal weight NYSE/AMEX/NASDAQ as market portfolio):

A correct response requires that you find an appropriate industry beta and measure for levered/unlevered betas and requires that you define cost of equity capital and free cash flow (FCF) – you may need a formula for FCF.

The historical beta comes from historical data. This kind of beta would slope coefficient in a regression, and associated with company's stock returns and market returns. This approach is conceptually straightforward, and complications quickly arise in practice.

* Stock Beta: Exhibit 5 shows a detailed measurement of the company’s stock returns in relation to the rest of the market through 5-year historical price and index data. The analysis includes monthly returns of both the NYSE and the S&P 500 index in order to capture a comprehensive view of the market return. In each comparison, the monthly returns of the Target stock and market are plotted on Y-axis and X-axis respectively to get the regression line’s slope or beta. The analysis arrives at an average beta of 0.988 which indicates a similar movement of Target stock’s returns in comparison to the whole market over time.

2. Beta, which is a measure of systemic risk, is a good indicator of how volatile a stock is relative to the market and it is a significant measurement to focus on when trading because the higher the beta, the greater the risk you gain in your portfolio. It is also important to make sure you allocate a lot of your money into commodities; their betas are usually low which is a good thing, especially if you are a risk-adverse investor. Conversely, higher beta stocks may be more volatile but they have the potential to generate higher returns then stocks with lower betas.

{. How many consecutives years the company has been profitable, its current ration and its ROE

The company’s debt ratios are 54.5% in 1988, 58.69% in 1989, 62.7% in 1990, and 67.37% in 1991. What this means is that the company is increasing its financial risk by taking on more leverage. The company has been taking an extensive amount of purchasing over the past couple of years, which could be the reason as to why net income has not grown much beyond several thousands of dollars. One could argue that the company is trying to expand its inventory to help accumulate future sales. But another problem is that the company’s

2. Compares the returns of the asset to the market over a period of time (Beta)

We use the equation ri=(Pt-Pt-1+Dt)/Pt-1 to calculate the monthly return of stock of Charles Schwab Corp, Quick & Reilly Group and Waterhouse Investor Srvcs. Then we have two methods to calculate the Beta of Equity for each company.

A common practice to determine the firm’s beta is to draw from historical data from published sources or compare numbers to competitors. In this case, Heinz can compare to Kraft, Campbell Soup and Del Monte and use professional judgement in determining the stock’s sensitivity to the market. A stock’s beta can be determined using a formula as well.

Of these 6 comparable companies, 3 of them are kitchen and bath companies and the rest 3 deals with engines and generators. Hence an average of the asset beta has been taken for these two sub groups which represent different business segments. Finally to arrive at the asset beta which would reflect the riskiness/volatility of Kohler, weighted average of these two betas has been taken as provided in the calculations below:

By using the company return and the Value Weighted Returns of the Market, we derived the companies’ levered equity betas and then unlevered them.

West Company's cost structure will include a larger proportion of variable costs than East Company's cost structure. A firm's operating leverage factor, at a particular sales volume, is defined as its total contribution margin divided by its net income. Since East Company has proportionately higher fixed costs, it will have a proportionately higher total contribution margin. Therefore, East Company's operating leverage factor will be higher.