Question

Faris currently has a capital structure of 40 percent debt and 60 percent equity, but is considering a new product that will be produced and marketed by a separate division. The new division will have a capital structure of 70 percent debt and 30 percent equity. Faris has a current beta of 1.1 but is not sure what the beta for the new division will be. AMX is a firm that produces a product similar to the product under consideration by Faris. AMX has a beta of 1.6, a capital structure of 40 percent debt and 60 percent equity, and a marginal tax rate of 40 percent. Assuming Faris's tax rate is 40 percent, estimate the levered beta for the new product division.

Answer 1

Answer:

Levered beta = Unlevered beta x  (1  + (1 - T)D/E

Levered beta  = 1.6 x  (1 + (1 - 0.4)70/30

Levered beta = 1.6  x  (1  +  0.6)70/30

Levered beta = 1.6 x (1.06)70/30

Levered beta = 3.96

Explanation:

Levered beta is also known as equity beta. It is calculated as unlevered beta multiplied by 1 + (1 - Tax rate) multiplied by debt-equity ratio of the division.