The equity beta of a levered firm is 1.2. The beta of debt is 0.2. The firm's market value debt to equity ratio is 0.5. What is the asset beta if the tax rate is zero?
A)1.20
B)0.73
C)0.20
D)0.87

Question

Quizplus · Accepted Answer

The asset beta (unlevered beta) can be calculated using the formula: Asset Beta = (Equity Beta / (1 + (1 - Tax Rate) * (Debt/Equity Ratio))) + (Debt Beta * (Debt/Equity Ratio) / (1 + (1 - Tax Rate) * (Debt/Equity Ratio))). With a tax rate of zero, the formula simplifies to: Asset Beta = (1.2 / (1 + 0.5)) + (0.2 * 0.5 / (1 + 0.5)) = 0.87.

The Equity Beta of a Levered Firm Is 1