Please answer the finance question. The questions need to be answered within 1 h
ID: 2733845 • Letter: P
Question
Please answer the finance question. The questions need to be answered within 1 hour, that is the deadline. Please answer the question within 1 hour and show all your work. If you cannot show all of your work or do not know how to do the problems, then please do not answer the question.
1. Greshak Corp. currently uses no debt and its beta is 1.10. Further, Greshak's CFO is considering moving to a capital structure with 30% debt and 70% equity. Assume the company's ROE is 12.0%, tax rate is 40.0%, the risk free rate and equity risk premium are 3.0% and 5.5%, respectively. What would its levered beta be if this revised capital structure were adopted? YOU MUST SHOW ALL WORK TO RECEIVE CREDIT!
Explanation / Answer
Steps: 1. Start with the beta of the business that the firm is in.
2. Adjust the business beta for the operating leverage of the firm to arrive at the unlevered beta for the firm.
3. Use the financial leverage of the firm to estimate the equity beta for the firm Levered Beta = Unlevered Beta ( 1 + (1- tax rate) (Debt/Equity))
Levered Beta = Unlevered Beta ( 1 + (1- tax rate) (Debt/Equity))
= 1.1(1+(1-0.4)(.0.3/0.7)) = 1.38