XYZ is considering altering its capital structure. Currently it has 40% debt and 60% equity. XYZ's levered beta is 2.0 under its current capital structure. The firm's tax rate is 40% which will not change if the capital structure is altered. What is the value of the levered beta if XYZ changes its capital structure to 50% debt, 50% equity? show your answer to 1 decimal place (example: a beta of 1.2)
XYZ is considering altering its capital structure. Currently it has 40% debt and 60% equity. XYZ's levered beta is 2.0 under its current capital structure. The firm's tax rate is 40% which will not change if the capital structure is altered. What is the value of the levered beta if XYZ changes its capital structure to 50% debt, 50% equity?
show your answer to 1 decimal place (example: a beta of 1.2)
Levered beta is the beta of the firm which has a mix of debt and equity, while unlevered beta is the beta of the company which has only equity
Formula:
Unlevered Beta = Levered Beta/ [1+(1-tax rate) * (Debt/Equity)]
In this we will unlever the beta and then relever it with the new Debt/Equity ratio
Levered Beta = Unlevered Beta * [1+(1-tax rate) * (Debt/Equity)]
Here,
Debt = 40% Equity =60%
Debt/Equity = 40/60 = 2/3 = 0.666667
Tax Rate = 40%
Levered Beta = 2
Unlevered Beta = Levered Beta/ [1+(1-tax rate) * (Debt/Equity)]
Unlevered Beta = 2/ [1+(1-.4) * (40/60)]
Unlevered Beta = 1.428571
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