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Eucalyptus Ltd. has 30 million shares outstanding, trading at $5 per share. Eucalyptus Ltd. also has...

Eucalyptus Ltd. has 30 million shares outstanding, trading at $5 per share. Eucalyptus Ltd. also has $40 million debt outstanding (market value) and $20 million cash in its vault. Suppose Eucalyptus Ltd has an equity beta of 1.3 and a debt beta of 0.8. What is the systematic risk of Eucalyptus Ltd.’s underlying business?

A.

1.30
B.

1.19
C.

1.24
D.

1.10
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Answer #1

Answer is B. 1.19.

systematic risk is the market risk or asset or firm's beta.

systematic risk = market weight of equity*equity beta + market weight of debt*debt beta

market weight of equity = market value of equity/(market value of equity + market value of debt)

market value of equity = no. of shares outstanding*market price per share = 30 million shares*$5 per share = $150 million

market value of debt is $40 million. market value of equity + market value of debt = $150 million + $40 million = $190 million

market weight of equity = $150 million/$190 million = 0.7894736842105263

market weight of debt = market value of debt/(market value of equity + market value of debt) = $40 million/$190 million = 0.2105263157894737

systematic risk = 0.7894736842105263*1.3 + 0.2105263157894737*0.8 = 1.026315789473684 + 0.1684210526315789 = 1.19

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