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24 August, 20:03

The required return on equity for an all-equity firm is 10.0 percent. They currently have a beta of one and the risk-free rate is 5 percent and the market risk premium is 5 percent. They are considering a change in capital structure to a debt-to-equity ratio of ½ the tax rate is 40 percent, the pre-tax cost of debt is 8 percent. Find the beta if this firm changes capital structure.

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  1. 24 August, 21:01
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    1.3

    Explanation:

    Data provided in the question:

    The required return on equity for an all-equity firm = 10.0 percent

    Risk-free rate = 5 percent

    Market risk premium = 5 percent

    Debt-to-equity ratio = ½ = 0.5

    Tax rate = 40 percent

    Pre-tax cost of debt = 8 percent

    All equity beta = 1

    Now,

    Levered beta with the new capital structure

    = All equity beta * [ 1 + Debt-to-equity ratio * (1 - tax rate) ]

    = 1 * [ 1 + 0.5 * (1 - 40%) ]

    = 1.3
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