agree on your post Re WACC. but how do you understand this: pension Asset weigh more on equity, firm must reduce debt, and to balance this firm must increase equity, the end result would be decreased debt/equity ratio… (don’t want to mechanically remember this) really have trouble with the logic… ok to elaborate? (to make this whole pension beta thing complete) ************************************************* Yeah, that’s right. Basically you add the DB liabilities to the debt of the balance sheet, add the pension assets to the assets of the balance sheet and recalculate some stuff. Total equity isn’t affected, but total debt, wacc, and beta are. Basically, the liabilities show up as more debt on the balance sheet, driving up the Debt/Equity ratio. This will affect the Asset Beta of the company (the beta that comes from operational risk as opposed to operational+financial risk) and make it lower. More importantly, this will increase the amount of debt in the capital structure, and lower WACC. If a company isn’t careful about this, it might use a higher WACC in their decisions to pursue projects and therefore reject some potentially profitable projects that would be feasible under the lower WACC.
there’s only one bchadwick but… “pension Asset weigh more on equity, firm must reduce debt, and to balance this firm must increase equity, the end result would be decreased debt/equity ratio… (don’t want to mechanically remember this)” This is kind of backwards. When the company adds equities to its pension fund, it’s creating “equity market risk” for itself (which would increase beta). Only way to offset this and leave the company’s total risk the same is to reduce risk in its capital structure, i.e. reduce leverage (or “gearing” if you’re European).
ryanunsw Wrote: ------------------------------------------------------- > agree on your post Re WACC. > > but how do you understand this: > > pension Asset weigh more on equity, firm must > reduce debt, and to balance this firm must > increase equity, the end result would be decreased > debt/equity ratio… (don’t want to mechanically > remember this) > I think I need more of the quote to make sense of this, but I suspect what they’re saying is that the company may have a target capital structure that was implemented using the balance sheet without pension assets and liabilities. When you add in the pension stuff, it is going to be mostly debt-like liabilities, and therefore throw the capital structure off. So a company should try to increase equity in order to bring its true capital structure back to the target. I would think that some companies that have their pension plans run by legally separate businesses would not need to worry about this, but companies that have their pension plans run within the same organization that issues stock for their primary business would need to worry about this. That’s all just a guess though… more context would help. And, BTW, I’m not claiming that I understand this stuff through and through, just I thought I could answer an earlier question. Anyone else care to jump in?
make sense i thought gearing is take on more debt = increase leverage not sure if this is right…de-gearing = de-leverage 
increase pension equities = higher pension beta = higher firm beta = reduce leverage (reduce risk of firm) to maintain WACC. decrease pension equities = lower pension beta = lower firm beta = increase leverage (increase risk of firm) tol maintain WACC. Since pensions are a liability, not including them as debt increases WACC of firm and may lead to turning down projects that should be accepted. Sorry if I repeated others, but I think these simple points are all you’ll need to know for the exam.
Checked example in Vol 2 Pg 388-390 of textbook this morning, D/E ratio is calculated using original debt /calculated equity. I had thought the total of original debt plus pension liabilities as numerator??? It seems to me that they think the total of origianl debt and equity is constant. So each time equity capital increases, debt goes down.
Vulture Wrote: ------------------------------------------------------- > increase pension equities = higher pension beta = > higher firm beta = reduce leverage (reduce risk of > firm) to maintain WACC. > > decrease pension equities = lower pension beta = > lower firm beta = increase leverage (increase risk > of firm) tol maintain WACC. > > Since pensions are a liability, not including them > as debt increases WACC of firm and may lead to > turning down projects that should be accepted. > > Sorry if I repeated others, but I think these > simple points are all you’ll need to know for the > exam. this is the only thing you need to know. the calc are not part of the LOS. selective studying ppl