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Financial Strategy for New Ventures

Willie Sutton Bank Vault Company has a debt-to-equity ratio of 0.75 and cost of debt of 15%. It is considering entering the automated teller business and looking at Peerless Machine Company as a proxy. Peerless has a debt-to-equity ratio of 0.25, beta of 1.15, and tax rate of 40%. If Willie Sutton uses the same leverage in the new business, its beta would be 1.15. Using a CAPM approach with a risk-free rate of 13% and expected market return of 17%, the required return for the project would be 16.05%.

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104 views1 page

Financial Strategy for New Ventures

Willie Sutton Bank Vault Company has a debt-to-equity ratio of 0.75 and cost of debt of 15%. It is considering entering the automated teller business and looking at Peerless Machine Company as a proxy. Peerless has a debt-to-equity ratio of 0.25, beta of 1.15, and tax rate of 40%. If Willie Sutton uses the same leverage in the new business, its beta would be 1.15. Using a CAPM approach with a risk-free rate of 13% and expected market return of 17%, the required return for the project would be 16.05%.

Uploaded by

florentina
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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11.

Willie Sutton Bank Vault Company has a debt-to-equity ratio (in market value terms) of

0.75. Its present cost of debt funds is 15 percent, and it has a marginal tax rate of 40 percent. Willie
Sutton Bank Vault is eyeing the automated bank teller business, a field that

involves electronics and is considerably different from its own line of business, so the

company is looking for a benchmark or proxy company. The Peerless Machine Company,

whose stock is publicly traded, produces only automated teller equipment. Peerless has a

debt-to-equity ratio (in market value terms) of 0.25, a beta of 1.15, and an effective tax

rate of 0.40.

a. If Willie Sutton Bank Vault Company wishes to enter the automated bank teller

business, what systematic risk (beta) is involved if it intends to employ the same

amount of leverage in the new venture as it presently employs?

b. If the risk-free rate currently is 13 percent and the expected return on the market portfolio is 17
percent, what return should the company require for the project if it uses a

CAPM approach?

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