Question

Boxcars, Inc. has a capital structure consisting of $100MM in equity and $150MM in debt. With...

Boxcars, Inc. has a capital structure consisting of $100MM in equity and $150MM in debt. With this capital structure, the expected return to its equity is 18 percent, the expected return to its debt is 7 percent, and the market beta of Boxcars enterprise value is 1.68. The risk-free rate is 3 percent. The firm unexpectedly issues $110MM in new shares, using the cash to repurchase $110MM of its debt. After the repurchase, the remaining $40MM in debt is risk-free because there is no chance the firm will default on the debt.

What is the market beta of Boxcars enterprise value after the change in capital structure? Assume CAPM is true

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Answer #1

Answer:

The Company has a capital structure consisting of

Equity - $ 100MM (40%)

Debt - $ 150 MM (60%)

Current levered beta = 1.68

Beta of Levered firm = Beta of Unlevered firm (1+Debt/Equity)

1.68 = Beta of Unlevered firm [1 + (150/100)]

Beta of Unlevered firm = 1.68/2.50 = 0.67

Beta of Levered firm needs to be calculated based on revised capital structure with Equity of 210MM and Debt of 40MM

Revised Beta of Levered firm = Beta of Unlevered firm (1+Debt/Equity)

Revised Beta of Levered firm = 0.67*(1+(40/210)) = 0.67*1.19= 0.7973

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