The Free-Float Company, a company in the 36% tax bracket, has riskless debt in its capital structure which makes up 40% of the total capital structure, and equity is the other 60%. The beta of the assets for this business is 0.8 and the equity beta is:

Question

Quizplus · Accepted Answer

The equity beta ($\beta_E$) can be calculated using the formula $\beta_E = \beta_A + (\beta_A - \beta_D) \times \frac{D}{E}$, where $\beta_A$ is the asset beta, $\beta_D$ is the debt beta (which is 0 for riskless debt), $D$ is the proportion of debt in the capital structure, and $E$ is the proportion of equity in the capital structure. Given that $\beta_A = 0.8$, $D = 40\%$, and $E = 60\%$, we can substitute these values into the formula. Since the debt is riskless, its beta ($\beta_D$) is 0, simplifying the formula to $\beta_E = \beta_A (1 + \frac{D}{E})$. Substituting the given values, we get $\beta_E = 0.8 (1 + \frac{0.4}{0.6}) = 0.8 (1 + \frac{2}{3}) = 0.8 \times \frac{5}{3} = 1.33$.

The Free-Float Company, a Company in the 36% Tax Bracket