Two firms have the same operating structure and the same operating systematic risk, ß = .8. Firm 1 has 20% debt in their capital structure while Firm 2 has four units of debt for every 7 units of equity. If the tax rate faced by both firms is 0.4 which has the riskier equity?
A) Firm 1 because it has a higher ratio of debt to equity.
B) Neither because they both have the same ß = .8.
C) Firm 2 because it has a higher ratio of debt to equity.
D) Neither firm because systematic risk is unaffected by the financing.

Question

Quizplus · Accepted Answer

Firm 2 has a higher ratio of debt to equity (4 units of debt for every 7 units of equity, which is more leveraged than Firm 1's 20% debt), making its equity riskier due to the increased financial leverage.

Two Firms Have the Same Operating Structure and the Same