BFC is an agribusiness with a highly variable cash flow, but where the risks tend to be related to weather, commodity pr

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BFC is an agribusiness with a highly variable cash flow, but
where the risks tend to be related to weather, commodity price
cycles and other random factors not closely tied to the business
cycle. Indeed, the correlation between the return on BFC equity and
the return on the S&P 500 is just 0.3. However, the variance of
the return on BFC’s equity is 12.25 times the variance of the
return on the S&P 500.
(a) What is the CAPM beta coefficient for BFC equity?
(b) If the current risk-free rate is 3% and the expected return
on the S&P 500
is 10.5%, what is the expected return on BFC equity according to
CAPM?
BFC currently has 75,000 shares outstanding currently selling at
$52.50 per share and no debt. BFC is considering diversifying into
food processing, which is a business with a much less variable cash
flow, but one that is also somewhat more correlated with the
business cycle. A traded firm that is closest to the type of
business BFC wishes to enter, GoodFood, appears to maintain a
debt/equity ratio of 0.6 (looking at its past balance sheets). The
return on GoodFood’s debt has a CAPM beta coefficient of 0.1, while
its equity CAPM beta is 0.8. Assume that the corporate tax effects
of debt approximate the overall effects of debt on the cost of
capital. The corporate tax rate is 34%.
(c) What is the current implied return on unlevered equity
for GoodFood?