Transcribed Image Text
You were appointed the CFO of a firm with 2 divisions:Div. 1 -- produces regular telephonesDiv. 2 -- produces specialty micro-chips which areused in cell phonesGiven Information:Market value of your firm’s debt = $100millionMarket value of your firm’s equity = $100millionOverall/total value of firm = $200 million.Beta of firms’ equity = 2Firm’s debt = riskless.Expected excess return on themarket over the riskless rate = 8% percentRisk-free rate = 2%Assume that the CAPM holds.Engineers in Division 2 now discover an opportunity to invest ina new production technology which would enable it to produce bettermicro-chips. The required investment would be $15 million today(t=0), but the investment would increase expected Division 2 salesrevenues by $4 million per year (each year, indefinitely, startingat t=1). You should assume that the systematic risk (the assetbeta) of Division 2 will be unaffected by the switch to the newproduction technology.Question 1: What is the asset beta for Division2?Question 2: Would you recommend that your firminvests in the new production technology?Question 3: Suppose your firm announces at t=0that it will invest in the new production technology and issues $15million worth of debt to finance the upfront investment.If there are 10 million shares outstanding, what will the price pershare be right after this has been done (i.e. right after t=0)?