Holooly Plus Logo
Holooly Plus Logo

Question 9.S-TQ5: Explain why the asset beta of a company will always be lower...

Explain why the asset beta of a company will always be lower than its equity beta, unless the company is all-equity financed.

The blue check mark means that this solution has been answered and checked by an expert. This guarantees that the final answer is accurate.
Learn more on how we answer questions.

The asset beta is the weighted average of the betas of equity and debt. Assuming that the beta of debt is zero, the asset beta will always be lower than the equity beta (unless the company is all-equity financed) because the market value of debt is not zero.

Related Answered Questions

Question: 9.EX.4.4

The CAPM in the investment appraisal process Arclight plc, a company producing high- ...

Verified Answer:

1 Ungearing the proxy companies’ equity betas to g...
Question: 9.S-TQ10

Briefly explain the traditional view of capital structure. ...

Verified Answer:

The traditional theory of capital structure propos...
Question: 9.S-TQ9

One-third of the total market value of Johnson plc consists of bonds with a cost of 10 per cent. York plc is identical in every respect to Johnson except that it is financed by equity alone. York’s cost of equity is 16 per cent. According to Modigliani and Miller, if taxation and tax relief on ...

Verified Answer:

Here we are assuming that the world of Miller and ...
Question: 9.S-TQ8

Describe the main factors influencing the choice and mix of financing used in foreign direct investment. ...

Verified Answer:

The main factors influencing the choice and mix of...
Question: 9.S-TQ7

What difficulties may be faced by analysts seeking to use the capital asset pricing model to determine a discount rate for foreign direct investment? ...

Verified Answer:

The following difficulties may be encountered by a...
Question: 9.S-TQ6

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. ...

Verified Answer:

Currently, β_e = 1.30, D = 0.25, ...
Question: 9.S-TQ4

Should companies use their current weighted average cost of capital as the discount rate when assessing the acceptability of new projects? ...

Verified Answer:

There are certain conditions that must be met in o...
Question: 9.S-TQ3

Pollock has in issue 1 million ordinary shares, nominal value 25p and £100,000 of 8 per cent irredeemable bonds. The current ex dividend market price of the ordinary shares is 49p per share and the current ex-interest market price of the bonds is £82 per £100 nominal. The company has just paid a ...

Verified Answer:

E = 1,000,000 × 0.49 = £490,000 D = 100,000 × 82/1...
Question: 9.S-TQ2

The 8 per cent irredeemable bonds of Eranio plc are currently trading at £92 per £100 bond. If the company pays corporation tax at a rate of 30 per cent, what is the current after-tax cost of debt of the bonds? ...

Verified Answer:

K_d = 8/92 = 8.7% K_d [/l...
Question: 9.S-TQ1

Gorky has in issue 500,000 £1 ordinary shares whose current ex dividend market price is £1.50 per share. The company has just paid a dividend of 27p per share and dividends are expected to continue at this level for some time. If the company has no debt capital, what is its weighted average cost of ...

Verified Answer:

Market value of equity, E = 500,000 × 1.50 = £750,...