hello everone
as i learned from curriculum the asset beta = stock beta / 1+ (1-tax%) (D/E%), and the orgin of this formula is Asset bata= debt beta + stock beta (until here it’s clear)
in the practice problems page 71 book 4 queation #10
they ask if a firm has a stable D/E% of 0.65 and recently they borrowed money and its D/E% increased to 0.75, what’s the effect on the assets beta and stock beta?
im confused with this answer, coz according to the above formulas, the stock beta is an component of asset beta, so if the D/E% increased the stock beta will increase whick will lead to the increase in the asset beta.
so anyone can hepl me to correct my concept ?
Remember that the whole point of the asset beta is to have a measure of a company’s business risk that excludes the financial risk (caused by leverage through debt, that’s why asset beta is also called unlevered beta).
In this question you are trying to estimate the business risk of an expansion of company A into South America, so the asset beta of a company who operates only in South America would be useful (pure play method), let’s call it company B. We obtain this asset beta by looking at the equity beta of company B, and deleverage their equity beta. Now once we have done that, we have an asset beta which we can apply for the project of company A (in this question the expansion to South America).
Once we arrive at an estimate of an asset beta, this does not change because of changes in company A’s D/E.
Alternatively, you could also use the average unlevered Betas of a couple of other companies in a similar business as company A and use that as company A’s asset beta. The important thing to keep in mind here is that you obtain the asset beta from other companys not from the company itself.
i’m Very thankful for u ma’am
it was sufficient answer