Question

Marshall Wines Corp. is a fine wine producer located in Temecula, California. It currently has 10 million shares outstanding with a current price of $20 per share. It also has debt with a market value of $100 million. Its asset beta is 1.25 and its equity beta is 1.75. Because of recent California’s law favoring wine producers, the company does not pay any taxes. What is the debt beta of Marshall Wines Corp.?

Answer 1

Asset beta is the weighted average of equity beta and debt beta, where the weights are based on the market value of each of the components.

Market value of equity = 10 million * $20 = $200 million

Market value of debt = $100 million

Weight of equity = $200 million/($200 million + $100 million) = 2/3

Weight of debt = $100 million/($200 million + $100 million) = 1/3

Asset beta = Weight of debt * debt beta + Weight of equity * Equit beta

1.25 = (1/3) * Debt beta + (2/3) * 1.75

1.25 = (1/3) * Debt beta + 1.1667

(1/3) * Debt beta = 0.0833

Debt beta = 0.25