An article in the Wall Street Journal on November 8, 2011 reported that U.S.-based Yum Brands has won approval from the Chinese government to purchase Little Sheep Group. Little Sheep owns a chain of hot-pot restaurants and trades on the Hong Kong stock exchange. The following table contains information from finance.yahoo.com on firms comparable to Little Sheep. Little Sheep’s current D/E ratio is 0.0433. After the merger, they are expected to have Yum’s D/E ratio of 0.13. Assume that all four companies have a tax rate of 35%.Levered BetaD/E ratio0.060.380.00a. Assuming debt is risk-free, use the information given above to estimate the unlevered equity betas of each of the comparable companies.b. Assuming debt is risk-free, what is your estimate of Little Sheep’s levered equity beta?c. If T-Bonds are yielding 2.07% and the market risk premium is 5.74%, what is the required return on Little Sheep’s stock, according to the CAPM?d. If Little Sheep has no preferred stock outstanding and their marginal pre-tax cost of debt is 5.08%, what is their weighted average cost of capital?
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