for Q8, I have different opinion, if pension asset increase equity investment from 0% to 80% equity, assuming pension asset equity beta don’t change (0.75), when equity in pension asset increase, total pension asset beta increases. we increase the equity and reduce debt, so total asset beta increase, since both total asset beta and pension asset beta increase, the answer says wacc will go up is wrong. wacc still the same.
for example, if operating asset beta didn’t change, equity in pension asset goes from 80% to 90%, the total asset Beta (both operating asset and pension asset) will increase because equity increase and debt reduce. but WACC is based on core operating asset beta not total asset beta. so wacc still the same
If pension assets increase allocation in equities: BETA (asset, plan) increases
BETA (asset, total = Plan +Operating assets) increases. To continue using the erstwhile BETA asset we need to lower the risk we reduce debt & increase equity in capital structure. This reduces the beta of equity shareholders & reduces the BETA (asset, operating asset). There are two rules:
In operating assets :
if D / E increases —risk of operating increases–BETA (equity) increases----BETA (asset, operating assets) increases
In pension plan assets :
if D / E increases – weight of equity decreases----BETA (equity) decreases----BETA (asset, plan assets) decreases…
if pension asset increase equity investment from 0% to 80% equity, assuming pension asset equity beta don’t change (0.75)
How can pension assets be at 0% and have 0.75 beta?
Also your next few words:
“for example, if operating asset beta didn’t change, equity in pension asset goes from 80% to 90%, the total asset Beta (both operating asset and pension asset) will increase because equity increase and debt reduce. but WACC is based on core operating asset beta not total asset beta. so wacc still the same”
There is no way that operating asset beta would stay the same when total assets beta and pension assets beta changed. operating assets beta is obtained by “backing out” the weighted beta. Please read the chapter carefully , particularly the words to do with taking more risk in operating assets when pension assets are less risky , and taking less risk in operating assets when pension assets are more risky
Re: Please read the chapter carefully , particularly the words to do with taking more risk in operating assets when pension assets are less risky , and taking less risk in operating assets when pension assets are more riskyopinion,
so in your opinion, when equity allocation in pension asset beta goes up, we should take less risk in operating asset, thus beta on operating asset should reduce, WACC is not based on total asset beta
thus WACC based on operating asset should reduce instead of going up(which is shown as answer in schweser) secondly, 0.75 will not change because when equity allocation, pension asset beta should be 0*0.75, which is zero, 90% equity in pension asset will end up 0.9*0.75 pension asset beta.
Thirdly, if WACC is based on total asset beta, then will increase, if wacc based on operating asset, no change, if mangement want to keep overall risk no change, increase equity, reduce debt, reduce operating asset beta, wacc reduce. anyone have other opinion? pls help forward my opinion to schweser
I got this problem wrong as well using the CAPM derivation of WACC based on operating asset beta. The question was confusing and was not specific in what it was looking for, especially since it followed a calculation of WACC using operating asset beta.
your statement is correct but not enough, I’m saying increase equity in the pension asset will not increase WACC(which is based on operating asset beta only)
The point is reduce debt, increase equity weight doesnt help to reduce firm risk. I think i have the same question in the link below. May it be another way to resate the question. It hasnt got answer yet though