Question

You are a CEO of a national restaurant chain. You are facing an investment proposal of building 20 new hotels across the country. Since hotel is a new business line for your company, the management finds Hilton Hotel corporation as one pure play company to assist the evaluation of this investment proposal. With the following information, what discount rate should you use to evaluate this investment proposal?

1 year government bond return: 0.85%

10 year government bond return: 2.41%

Expected market risk premium: 5%

Info on Hilton

Equity return: 6.20%

Equity beta: .76

Debt to value ratio: 14%

Marginal tax rate: 40%

Info on your company

Book value of long-term debt: $5,000,000

Book value of equity: $5,000,000

Share price: $15

Number of shares outstanding: 1,000,000

Debt rate premium above government bonds is 3%

Marginal tax rate: 40%

The equity beta for this hotel investment project is _______________

Answer 1

Unlevered Beta =Equity Beta / (1+(Debt / Equity)*(1 - Tax rate))

Unlevered Beta = 0.76 / (1+(14%)*(1 - 40%))

Unlevered Beta = 0.70

Debt to market value = Debt / (Shares * Share price)

Debt to market value = 5000000 / (1000000 * 15) = 0.33

Levered Beta = Unlevered Beta * [1 + (1 – Tax Rate) * (Debt / Equity)]

Levered Beta = 0.70 * (1 + (1 - 40%) * (0.33))

Levered Beta = 0.84

The equity beta for this hotel investment project is 0.84