Clementi Corp. has debt in the form of 8.00% coupon bonds that have 14 years remaining until maturity. These bonds pay interest semiannually, and have a yield of 4.25% at the present time. The book value of these bonds is $125 million. The company’s common stock is currently trading at 88.90 per share. There are 2.25 million shares of Clementi stock outstanding. The firm has no preferred stock. There is insufficient price history for Clementi stock to allow you to estimate the company’s equity beta, so you turn to a comparable firm that has sufficient data.
You use regression analysis to estimate the beta for this comparable firm. Your results suggest a beta of 1.30. In market value terms, the comparable firm has a $298 million of debt and $480 million of equity. Both Clementi Corp. and the comparable firm face a 35% marginal tax rate.
- Estimate the equity beta for Clementi Corp.
- If the risk-free rate is 2.80% and the market risk premium is 6.25%, estimate the required rate of return on Clementi stock.