Question 9.S-TQ6: A company has an equity beta of 1.30 and is financed by 25 p...
A company has an equity beta of 1.30 and is financed by 25 per cent debt and 75 per cent equity. What will be the company’s new equity beta if it changes its financing to 33 per cent debt and 67 per cent equity? Assume corporation tax is 30 per cent.
Currently, β_e = 1.30, D = 0.25, E = 0.75
Hence: β_a = β_e × (E/(E – D(1 – C_T )))
= 1.30 × 0.75/(0.75 – (0.25 × 0.7))
= 0.975/0.9125 = 1.0541
If, now, D = 0.33 and E = 0.67 then:
β_e = β_a × (1 + (D(1 – t)/E)) = 1.0541 × 1.345 = 1.42
The new equity beta is therefore 1.42.
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