23.15

15. Compaq is in the process of buying Dell. You read in Value Line that Compaq's equity beta is 1.4 and Dell's is 1.5. The risk free rate is 3% and the expected return on the market is 12%.

1. You make the assumption that both Compaq and Dell have no debt. What discount rate should Compaq use to determine the purchase price? (5 pts)
   E[R] = .03+1.5(.12-.03)=.165
   
2. If your assumption is wrong, will your discount rate be too high, too low, or correct? Why? (5 pts)
   
   Too high. If Dell has debt, the equity will be riskier than the underlying assets of the company. Since the Beta of the equity is higher than the beta of the assets in this case, and Dell's equity beta is 1.5, using 1.5 gives too high of a discount rate.

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