Question

1. Gener Motors (GM) has an unlevered equity beta of 0.56 and the debt beta for a BBB credit is 0.24. We also know that GM's CFO likes to keep the debt to value ratio at 1/3. We also know that the risk free rate on a T bill is 2% while the market expected return is 12%. Based on this information, please estimate the levered equity beta and the Expected return for GM stock.

   		0.72; 9.20%
   		1.0; 12.00%
   		1.20; 14.0%
   		0.80; 10.0%

Answer 1

Unlevered equity beta, ul = 0.56

Debt to value = 1/3 ie D/E = 1/2=  0.5

e = ul + (ul - debt) *(1+ D/E)

= 0.56 + (0.56-0.24)* 1.5 = 1.04

Expected return = Risk free rate + e *(Market return - Risk free rate) = 2% + 1.04*(12% -2%) = 2% + 10.04% = 12.04%

Answer is 1.0; 12.00%