Question

Wang Securities had debt-to-equity ratio of 0.65. The CFO wants to issue some stock and buy back and equivalent amount of debt. It is estimated that the debt-to-equity ratio after this action will be 0.55. The increased leverage has what effect on unlevered beta and levered beta of the company?
a. The unlevered beta and the levered beta will both rise.
b. The unlevered beta will remain the same and the levered beta will decline.
c. The unlevered beta will increase, and levered beta will decline.
d. The unlevered beta and levered beta will both decline.
e. The unlevered beta will remain the same and the levered beta will rise

Answer 1

Answer:

b. The unlevered beta will remain the same and the levered beta will decline.

Explanation:

Unlevered beta excludes the effect of debt on the investment. It represents only the risk associated with equity of the company. Change in the debt to equity ratio will not effect the unlevered beta. Unlevered beta will remain same.

Unlevered beta includes the effect of debt on the investment. It represents the risk associated with equity and debt of the company. Change in the debt to equity ratio will change the unlevered beta. Unlevered beta will decline with the reduction in debt to equity ratio as risk associated with debt decreases.