An analyst gathers the following information for Firm A and Firm B.Use the information to compute the industry unlevered beta and the appropriate beta for Firm B to use in the WACC. Firm A: CAPM beta = 1.6;debt-to-equity ratio = 1.2
Firm B: CAPM beta = 1.0;debt-to-equity ratio = 0.8
The appropriate beta for Firm B is closest to:

Question

Quizplus · Accepted Answer

To find the appropriate beta for Firm B, we first need to calculate the unlevered beta for the industry, which involves unlevering the beta for Firm A and Firm B and then averaging them. The formula to unlever beta is: Unlevered beta = Levered beta / (1 + (1 - Tax rate) * Debt/Equity ratio). Assuming a tax rate of 0 (for simplicity, as it's not provided), the unlevered betas for both firms are:- Firm A: 1.6 / (1 + 1.2) = 0.7273- Firm B: 1.0 / (1 + 0.8) = 0.5556Average unlevered beta = (0.7273 + 0.5556) / 2 = 0.64145Then, we re-lever the beta for Firm B using its debt-to-equity ratio. The formula to re-lever beta is: Levered beta = Unlevered beta * (1 + (1 - Tax rate) * Debt/Equity ratio). Again, assuming a tax rate of 0:- Appropriate beta for Firm B = 0.64145 * (1 + 0.8) = 1.1546Therefore, the closest answer is 1.154.

An Analyst Gathers the Following Information for Firm a and Firm