The Granite Paving Co. wishes to have debt-to-equity ratio of 1.5. Currently it is an unlevered (all equity) firm with a beta of 1.1. What will be the beta of the firm if it goes through the capital restructuring process and attains the target debt-to-equity ratio? Assume a tax rate of 30%.

Question

Quizplus · Accepted Answer

The correct answer is A.The beta of the firm will increase after the capital restructuring process because the firm will be taking on more debt. The debt will have a higher beta than the equity, so the overall beta of the firm will increase. The new beta can be calculated using the following formula:New beta = Unlevered beta * (1 + (1 - Tax rate) * (Debt-to-equity ratio))New beta = 1.1 * (1 + (1 - 0.3) * (1.5))New beta = 2.26