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Firm A has a beta of 1.5. Firm B has a beta of 1. Both firms...

  1. Firm A has a beta of 1.5. Firm B has a beta of 1. Both firms A and B are in the same industry, i.e. have similar assets. Which of the following could be a reason why Firm A has a higher beta than Firm B’s?

  1. Firm A has more cyclical revenues than Firm B
  2. Firm A has high financial leverage compared to Firm B
  3. Firm A has low financial leverage compared to Firm B

  1. I only
  2. II only
  3. I and II
  4. II and III
  5. I, II and III
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Answer #1

The correct answer is Option C

The Firm A could have higher beta because of higher financial leverage as higher level of debt increase the levered beta. The company with higher debt has to make regular payment to the debtholders which affects their operating performnce negaitvely. So, It adds more risk to the firm.

The firm with higher cyclical revenue means that the company gets higher revenue when economy expands and falls when the economy contracts, so this shows that the company would higher volatility which increases the beta.

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