ECRI is considering a change in its strategic focus; it will reduce its reliance on the electric utility subsidiary,

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ECRI is considering a change in its strategic focus; it will reduce its reliance on the electric utility subsidiary,

BETA AND THE REQUIRED RATE OF RETURN

ECRI Corporation is a holding company with four main subsidiaries. The percentage of its capital invested in each of the subsidiaries (and their respective betas) is as follows:

a. What is the holding company’s beta?

BETA AND THE REQUIRED RATE OF RETURN

ECRI Corporation is a holding company with four main subsidiaries. The percentage of its capital invested in each of the subsidiaries (and their respective betas) is as follows:

b. If the risk-free rate is 4% and the market risk premium is 5%, what is the holding company’s required rate of return?

BETA AND THE REQUIRED RATE OF RETURN

ECRI Corporation is a holding company with four main subsidiaries. The percentage of its capital invested in each of the subsidiaries (and their respective betas) is as follows:

c. ECRI is considering a change in its strategic focus; it will reduce its reliance on the electric utility subsidiary, so the percentage of its capital in this subsidiary will be re duced to 50%. At the same time, it will increase the firm’s reliance on the international/special projects division, so the percentage of its capital in that subsidiary will rise to 15%. What will the company’s required rate of return be after these changes?

Answer & Explanation (3)

part a
Explanation
Calculate weighted average portfolio beta.

Beta = Sum of (Weighted Averages x Betas)

=(.6 x .7) + (.25 x .9) + (.10 x 1.3) + (.05 x 1.50)

= .85

Verified Answer
Beta = .85

part b
Explanation
Calculate required rate of return (RR).

RR = Risk Free Return + (Market Risk Premium x Beta)

=.04 + (.05 x .85)

= 8.25%

Verified Answer
Required rate of return = 8.25%

part c
Step 1 of 2
Calculate weighted average portfolio beta.

Beta = Sum of (Weighted Averages x Betas)

=(.5 x .7) + (.25 x .9) + (.10 x 1.3) + (.15 x 1.50)

= .93

Step 2 of 2
Calculate required rate of return (RR).

RR = Risk Free Return + (Market Risk Premium x Beta)

=.04 + (.05 x .93)

= 8.65%

Final answer
Beta = .93

Required rate of return = 8.65%

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