Company GoodHouse Inc. currently focuses on real estate business. As the CEO you plan to develop the business in a new field, Metaverse, for diversification and growth purpose. Wikipedia describes Metaverse as “a hypothesized iteration of the Internet, supporting persistent online 3-D virtual environments through conventional personal computing, as well as virtual and augmented reality headsets.” To estimate the cost of equity for this project, you use the Pure-Play technique and collect the information on pure-play firms dealing with Metaverse, as shown in the following table Company Name Equity beta Equity/(Equity + Debt) Tax rate V-Game 3.0 70% 25% Meta Horizon 4.0 80% 15% Your project will be funded as follows: 20% by debt and 80% by equity. The tax rate is 20%. The risk-free rate is 3%. The average return on the S&P 500 index over the past five years is 8%. REQUIRED: Please calculate the equity beta of your Metaverse project using the Pure-Play technique. 2. Please describe the general meaning of beta in the theoretical framework of CAPM, e.g. what it measures and its link with returns. 3. Please calculate the required return on equity of your Metaverse project using CAPM. 4. What are the main assumptions of CAPM? Briefly discuss whether they are realistic in practice. Is relevant empirical evidence always consistent with CAPM? In particular, what have you learned about the empirical findings on stock returns related with firm size and book-to-market ratio?

Corporate Fin Focused Approach

5th Edition

ISBN:9781285660516

Author:EHRHARDT

Publisher:EHRHARDT

Chapter13: Agency Conflicts And Corporate Governance

Section: Chapter Questions

Problem 1hM

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Company GoodHouse Inc. currently focuses on real estate business. As the CEO you plan to develop the business in a new field, Metaverse, for diversification and growth purpose. Wikipedia describes Metaverse as “a hypothesized iteration of the Internet, supporting persistent online 3-D virtual environments through conventional personal computing, as well as virtual and augmented reality headsets.”

To estimate the cost of equity for this project, you use the Pure-Play technique and collect the information on pure-play firms dealing with Metaverse, as shown in the following table

Company Name	Equity beta	Equity/(Equity + Debt)	Tax rate
V-Game	3.0	70%	25%
Meta Horizon	4.0	80%	15%

Your project will be funded as follows: 20% by debt and 80% by equity. The tax rate is 20%. The risk-free rate is 3%. The average return on the S&P 500 index over the past five years is 8%.

REQUIRED:

Please calculate the equity beta of your Metaverse project using the Pure-Play technique.

2. Please describe the general meaning of beta in the theoretical framework of CAPM, e.g. what it measures and its link with returns.

3. Please calculate the required return on equity of your Metaverse project using CAPM.

4. What are the main assumptions of CAPM? Briefly discuss whether they are realistic in practice. Is relevant empirical evidence always consistent with CAPM? In particular, what have you learned about the empirical findings on stock returns related with firm size and book-to-market ratio?

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