Guys, Do we need to know the calculations for this one ? The operating beta and the asset beta and the changing of the equity capital… Blah…Blah… Appreciate the response. Thanks
I would…make sure you know how to calculate the operating asset beta when given pension asset beta. Total asset beta=operating asset beta+pension asset beta.
but does’t schweser specifically say that you don’t need to know the calculations for this one.
No, just know how including pension assets will impact the WACC.
Thanks for your responses. I do not understand the calculations on page 52 of schewesers book 2. Can you guys clarify this ?
The idea of this whole thing is based on the fact when calculating WACC, firm should use it operating asset’s beta. So… On page 52, Schweser 2, you must be referring to the example in the blue box. The top equations is the 1st step to calculate the beta of all asset (operating and pension). You get 0.43 as the beta. Next, you need to back out the operating beta (the true beta that is used to calculate WACC) from the All asset beta. And that is shown in the second equation. The whole firm beta (operating asset and pension asset) equals the weighted average of operating asset and pension asset. Total asset is 45, 20 of it is operating asset, and 25 of it is pension beta. On the exam, I believe pension beta has to be given (if this kind of math shows up). After all that mess, you get operating beta 0.22. Now, if you use 0.43 as your beta (instead of the true operating asset beta of 0.22), you will end up with a higher WACC…bad! Why bad? Your WACC is too “high”, you will more likely to reject profitable project. Helps? This whole example is to show you why the statement of “Not including pension asst in WACC calculation will result in a higer WACC” is mathatically true.
Thanks WS for responding so quickly. My confusion is with the first calculation when you get the beta of .43. Ba = Weight of debt + weight of equity = 34 ( 25+9)/45 (0) + 11 ( Should be 11+ 15) ??? /45 * (1.75) = .43 the weight of equity in the portfolio of assets should be 11 + 60% of pension assets are equity 15MM? Thanks in advance for making my dog days bearable.
NO!! It is assumed that there is no equity in the pension portfolio. So pension asset equal pension liablity. Therefore overall equity of the firm doesn’t change. Both of your asset and liability (pension) increase by the same amount.
That’s exactly what confuses me. If you include pension liabilities in the calculation, assets should be included too-right ? What’s the logic of including only the liabilities and not the assets ? wouldn’t it paint a biased picture ?
No, you (the calculation) are including both pension asset and pension liability. Look at the equation. Flip back to page 51, pay close attention the the balance sheet on page 51 and page 52. You will see. Both pension asset and pension liability are included. Asset is reflect too, Your original asset is 20 (page 51), after you included the pension asset, your total asset become 45 (page 52).
derswap07 Wrote: ------------------------------------------------------- > > the weight of equity in the portfolio of assets > should be 11 + 60% of pension assets are equity > 15MM? > What the??? Where did you get 60% from?
I see that. 45 is fine. It’s the total assets. The question is that assets include both- equity and debt. The first ratio is weight of debt * beta of debt ( which is zero) plus weight of equity * beta of equity * total beta of equity. Debt is fine- 34 = 9 ( operating ) + 25 Pension liabilities which is treated as debt. Equity is 11 - which is the original operating beta portion. My q is why the equity portion of the pension assets ( 60 %) given at the top of the page 52-which comes out to be 15 MM ( 60% of 25 MM) is not included in this calculation ?
I think you may have the word “equity” confused. Equity in this context is talking about A-L, not stock. On top of the page 52, the word “equity” means the stock portion of the pension asset. 11/45, the 11 equity means the A-L equity (net worth). Make sense now?
Thanks ws. It does make sense now. You cleared up my confusion. You have my blessings to pass…
derswap07 Wrote: ------------------------------------------------------- > Thanks ws. It does make sense now. You cleared up > my confusion. > > You have my blessings to pass… Thanks!!!