2N5.3
3. Computer Associates is trying to buy Computer Sciences. Assume:
CA has an equity beta of 1.5 and a debt beta of 0.2. It has $8bn
in equity and $2bn in debt. CS has an equity beta of 1.6 and a
debt beta of 0.24. It has $6bn in equity and $2bn in debt. The
risk free rate is 3% and the expected return on the market is 12%.
What discount rate should CA use to determine what price to pay
for CS? (3 pts)
The appropriate rate to use is the discount rate that
accounts for the risk of CS, not the one that comes from CA's
risk. Thus, the information about CA is irrelevant. CA should use
CS' risk to calculate the appropriate discount rate for this
project. The first step is to get the beta for CS' assets. The
second step is to use that beta to get the appropriate discount
rate.
Discount Rate: 14.3%