Assuming that there is an unlevered firm and a levered firm. The basic information is given by the following table. Table 1: Information of the firms Unlevered firmLevered firmEBIT10,00010,000Interest03,200Taxable income10,0006,800Tax (tax rate: 34%)3,4002,312Net income6,6004,488CFFA0-3,200 Assuming that cost of debt =8%; unlevered cost of capital =10%; systematic risk of the asset is 1.5Suppose that the firm changes its capital structure so that the debt-to-equity ratio is 1.0, then recalculate the systematic risk of the equity

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Asked Dec 3, 2019
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Assuming that there is an unlevered firm and a levered firm. The basic information is given by the following table.

 

Table 1: Information of the firms

 

Unlevered firm

Levered firm

EBIT

10,000

10,000

Interest

0

3,200

Taxable income

10,000

6,800

Tax (tax rate: 34%)

3,400

2,312

Net income

6,600

4,488

CFFA

0

-3,200

 

Assuming that cost of debt =8%; unlevered cost of capital =10%; systematic risk of the asset is 1.5

Suppose that the firm changes its capital structure so that the debt-to-equity ratio is 1.0, then recalculate the systematic risk of the equity

 

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Expert Answer

Step 1

The formula to calculate systematic risk of equity is given below:

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Debt Systematic risk of asset x|1+(1- Tax rate) x Equity Systematic risk of equity

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Step 2

Substitute 1.5 for systematic risk of asset, 0.34 fo...

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Systematic risk of equity 1.5x (1+(1-0.34) (1)) = 1.5 x1.66 = 2.49

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