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SolPProblem10

# SolPProblem10 - CARNEGIE MELLON UNIVERSITY Tepper School of...

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CARNEGIE MELLON UNIVERSITY Tepper School of Business Finance (70-391) Summer 2009 Practice Problems Topic 10 Solution 1. (a) For projects in the Brandy division 0 : 12 = 0 : 04 + (0 : 10 ° 0 : 04) ° B ) ° B = 1 : 333 ; while for projects in the Wine division 0 : 10 = 0 : 04 + (0 : 10 ° 0 : 04) ° W ) ° W = 1 : (b) Let ° A and ° E respectively denote the asset beta and the equity beta consistent with the discount rates currently used by Brandywine°s two divisions. Then ° A = 0 : 5 ° B + 0 : 5 ° W = 1 : 167 ; and ° A = D D + E ° D + E D + E ° E , 1 : 167 = (0 : 3)(0) + 0 : 7 ° E ; so that ° E = 1 : 6667 > 1 : 6 : Therefore, the equity beta implicit in the discount rates used by the two divisions is slightly higher than your estimate. (c) The asset beta for the Brandy division can be approximated by the asset beta for Korbell. Hence ° B = 2 5 (0 : 2) + 3 5 (1 : 8) = 1 : 16 : This implies a discount rate for new projects in the Brandy division of 0 : 04 + (0 : 10 ° 0 : 04) ° B = 10 : 96% : To estimate the asset beta for the Wine division, note that an equity beta of 1.6 for Brandywine implies an asset beta of ° A = 3 10 (0) + 7 10 (1 : 6) = 1 : 12 : Hence, 1 : 12 = 0 : 5(1 : 116) + :

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