Chapter 9.A, Problem 3P

Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
ISBN: 9781337395250

Chapter
Section

Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
ISBN: 9781337395250
Textbook Problem

BETA COEFFICIENTS Suppose Chance Chemical Company’s management conducted a study and concluded that if it expands its consumer products division (which is less risky than its primary business, industrial chemicals), its beta will decline from 1.2 to 0.9. However, consumer products have a somewhat lower profit margin, and this would cause its constant growth rate in earnings and dividends to fall from 6% to 4%. The following also apply: rM = 9%, rRF = 6%, and Do = \$2.00. a. Should management expand the consumer products division? Explain. b. Assume all the facts given except the change in the beta coefficient. How low would the beta have to fall to cause the expansion to be a good one? (Hint Set P ^ 0 under the new policy equal to P ^ 0 , under the old one, and find the new beta that will produce this equality.)

a.

Summary Introduction

To explain: Whether the management should expand the consumer product division or not.

Introduction:

Stock:

Stock is an asset for the investors and a liability for the company. A stock is a kind of investment made by the investors, who want to get more return. An investor holds the ownership right after the purchase of a stock of the respective company.

Explanation
• The fluctuation in share prices directly affect the consumer behavior, so management always wants the stock price to be high.
• The required rate of return is reduced from 9.6% to 8.7%, so it is a loss of 0.9% of return, so the management will not expand the consumer product division...

b.

Summary Introduction

To compute: The amount by which the beta coefficient falls to make the expansion good.

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