What will the firm's equity beta be if it gets rid of all its debts?

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BlackTom AI · Accepted Answer

The question asks: What will the firm's equity beta be if it gets rid of all its debts?

First, recall the key concept: a firm’s equity beta when it has debt (levered beta) is higher than its asset beta due to financial leverage. The asset beta (unlevered beta) reflects the business risk without financing effects. If there were no debt, the equity would be the asset itself, so the equity beta would equal the asset beta (the unlevered beta).

Since the provided data have no answer options to examine, we cannot pick among alternatives. In general terms, removing debt eliminates financial risk from leverage, so the new equity beta should move toward the firm’s asset beta. The relationship often cited is beta_unlevered = beta_levered / [1 + (1 - tax_rate) * (Debt/Equity)]. When Debt/Equity goes to 0 (no debt), beta_unlevered remains as the asset beta, which is the equity beta after debt is removed.

If you had a numeric levered beta and a tax rate along with the current debt/equity ratio, you could compute the unlevered (asset) beta using that formula. Conversely, if you were given the unlevered beta or the asset beta, that value would be the equity beta once all debt is eliminated.

Without the missing answer options or the current levered beta, debt level, and tax rate, we cannot confirm a specific numeric value for the post-debt equity beta. If the stated correct value is 1.08, that would imply the firm’s asset beta (unlevered beta) is 1.08 under the assumption of no debt, or that the calculation has already isolated the unlevered beta from the current capital structure using the standard formula.

Summary of the core idea: removing all debt eliminates financial leverage, so the new equity beta equals the firm’s asset (unlevered) beta. The exact numeric result depends on the original levered beta, debt ratio, and tax rate, and cannot be determined from the information given here without those values.

FA25-BL-BUS-F305-1130 Problem Set 5 (Please read the instruction)

What will the firm's equity beta be if it gets rid of all its debts?

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