The asset beta of a levered firm is 1.1.The beta of debt is 0.3.If the debt equity ratio is 0.5,what is the equity beta? (Assume no taxes.)
A)1.5
B)1.1
C)0.3
D)0.15

Question

Quizplus · Accepted Answer

First, we need to calculate the unlevered beta using the debt beta and debt-to-equity ratio:

Unlevered Beta = Asset Beta / (1+(1-t)*D/E) 
where, D/E is the Debt to Equity ratio and t is the tax rate (0 in this case).
 
So, Unlevered beta = 1.1 / (1 + 0.5 * (1-0)) = 0.7333

Next, we can use the unlevered beta and the debt-to-equity ratio to calculate the equity beta:

Equity Beta = Unlevered Beta * (1+ (1-t) * D/E)

Equity Beta = 0.7333 * (1 + 0.5 * (1-0)) = 1.1

Therefore, the equity beta is 1.1. The correct answer is A.

The Asset Beta of a Levered Firm Is 1