Schweser pg 202, book 2 W e,p (weight of equity securities in plan assets) is taken as 0.75 for calculating Total asset beta. (Given as an assumption in Prof’s note for the illustration) However while calculating Equity needed on B/S to maintain equity beta of 1.75, why is it assumed that (W e,p = 0)? I am missing something here?
It’s convoluted calculation based on the idea that you’re trying to maintain constant equity beta for the company. Or put it this way: company thinks that it’s equity beta is 1.75 and than all of a sudden it realises that it has a pension plan! The question is now how to bring combined beta back to 1.75. That’s why they use this zero weight in the second part of calculation. Anyway, they suggest not to focus on calculations since you’ll never have to calculate it this way. That’s how I see it.
Thanks Bokonon, A) As per the 3rd para on pg 201, 1.75 is the firm’s equity beta & the attempt is to maintain it at the same level. The calculations on pg 202 also use it as firm’s equity beta. B) If you look at the debt /equity ratio (highlighted in bold in the table on page 201) the figure is 0.51 at this level. As per the 3rd para on pg 201, this is the firm’s D/E ratio. 13.24/ (1-0.51) = 13.24/0.49 = 27 = New level of total operating assets. So post this adjustment – 1) Is W a,o which was 20/45 is now at 27? 2) Is W a,p which was 25/45 remains at 25? The only decent calculation in the entire book 2 & I am not getting it right!