Question

An analyst gathers the following comp set consisting of Firm A and Firm B. Estimated debt beta for each firm equals 0.2.
Firm A: CAPM beta = 0.8; debt-to-equity ratio = 0.5
Firm B: CAPM beta = 1.4; debt-to-equity ratio = 2.5

All debt is perpetual, no new issuances or debt retirements are planned.

a)Using the information to compute the industry unlevered beta.

b) Find WACC for a similar firm C with debt-to-equity ratio of 1?

Answer 1

a. The tax rates are not given, hence we assume tax rate =0

As per hamada equation, beta Unlevered= Beta levered/ (1+(1-tax rate)*D/E))

Now, the beta levered = CAPM beta of the industry = (0.8+1.4)/2 = 1.1 (Again we assume there are only these two firms in the industry)

Average D/E =(0.5+2.5)/2 = 1.5

beta Unlevered= Beta levered/ (1+(1-tax rate)*D/E))

beta Unlevered= 1.1*(1+(1-0)*1.5) = 1.1/2.5 = 0.44

Unlevered beta = 0.44

b. To calculate the WACC we need the expected risk free return and the market risk premium which are not given.