1. (a) Suppose Carter Chemical Company'smanagement conducts a study and concludes that if Carter expandsits consumer products division (which is less risky than itsprimary business, industrial chemicals), the firm's beta willdecline from 1.1 to 0.9. However, consumer products have a somewhatlower profit margin, and this will cause Carter's growth rate inearnings and dividends to fall from 7 percent to 6 percent. Shouldmanagement make the change? Assume the following:
E[RM]= 10%; RF=7.5%; D0 =$2.
Assume all the facts as given in part (a), except the one about thechanging beta coefficient. By how much would the beta have todecline to cause the expansion to be a good one? (Hint: set P0under the new policy equal to P0 under the old one, and find thenew beta that produces this equality.)
