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. The tax rate faced by both firms is.4. The debt beta is assumed to zero. What is the difference in systematic risk between the riskier firm and the less risky firm?
A) 0.26 Firm 2 beta greater than Firm 1 beta.
B) 0.15 Firm 2 beta greater than Firm 1 beta.
C) 0.30 Firm 2 beta greater than Firm 1 beta.
D) 0.10 firm 2 beta greater than Firm 1 beta.

Question

Quizplus · Accepted Answer

Firm 1 has a debt-to-equity ratio of 0.25 (20% debt), while Firm 2 has a debt-to-equity ratio of 4/7. Using the formula for levered beta: βL = βU * [1 + (1 - tax rate) * (D/E)], we calculate the difference in levered betas. The difference is 0.15.

Two Firms Have the Same Operating Structure and the Same