Beta for a project?

dejavu wrote:
dejavu wrote:I came across a question in which a company increases its debt-equity ratio from 0.5 to 0.6 and the changes in asset and equity betas are asked.
I know the correct answer is that asset beta is not affected by debt-equity ratio, and only the equity beta will undergo an increase.
But if asset beta is NOT affected by leverage or debt, why is it equal to the sum of Beta (Debt) and Beta (Equity), i.e. Beta (asset) = Beta (debt) + Beta (equity)?
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Please resolve this doubt of mine.
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I think that the point you’re missing is that in the formula
Assets(βA) = Debt(βD) + Equity(βE)
the constant here is βA: the asset beta. It is unaffected by leverage. If you change the leverage (and for simplicity, keep the value of assets constant, so that the left side of the equation doesn’t change), then either βD or βE will have to change. That’s the point: leverage affects the equity beta, but not the asset beta.
dejavu wrote:I also have a doubt with this question:
Quote:Company A has a debt equity ratio of 2.0. A is evaluating the cost of equity for a project in the same line of business as Company B and will use the pure-play method with B as the comparable firm. B has a beta of 1.2 and a debt equity ratio of 1.6. The project beta most likely:
a) Will be less than A’s Beta
b) Will be greater than A’s Beta
c) Could be greater or less than A’s Company Beta
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I guessed the correct option (c) but I only did so because there is a possibility that A and B are in entirely different tax brackets. Is there any other reason you could think why (c) is the correct answer?
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The project beta will be less than Company A’s equity beta: the correct answer is a), not c). (If the author of the question said that the correct answer is c), he’s wrong. Was there any explanation given with the “correct” answer?)
Company A has leverage, and leverage increases the equity beta; it doesn’t affect the asset beta.
All of the information about company B is irrelevant in answering this question: if Company A is levered, its equity beta will be higher than its asset beta.
(Note: if Company A’e equity beta were negative, it’s possible that the asset beta would be higher (i.e., less negative). But that’s an absurd situation; if that’s the author’s reasoning for c) instead of a), the author is being a jerk.)
 
Thanks, I now understand that Beta (asset) is a constant and remains unaffected by Beta (equity).
And regarding my second doubt, I think the author wants us to make the comparison between B’s equity beta and A’s levered Beta (which we will obtain after unlevering B’s equity beta and re-levering to suit A). I do not think his intention was to ask us to compare A’s asset beta to A’s equity beta (if so, then the latter would be more than the former, even if A had a debt-equity leverage between 0 and 1). Correct me if I’m wrong?
 
dejavu wrote:Thanks, I now understand that Beta (asset) is a constant and remains unaffected by Beta (equity).
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Good to hear.
dejavu wrote:And regarding my second doubt, I think the author wants us to make the comparison between B’s equity beta and A’s levered Beta (which we will obtain after unlevering B’s equity beta and re-levering to suit A). I do not think his intention was to ask us to compare A’s asset beta to A’s equity beta (if so, then the latter would be more than the former, even if A had a debt-equity leverage between 0 and 1). Correct me if I’m wrong?
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If that’s what the author wanted, it’s not remotely what he asked.
All in all, it’s a lousy question.
 
Remember that levered beta is the equity beta and the unlevered beta is the asset beta.
 
Maybe you you just send Bluebook Academy a short message regarding this if it’s convenient for you. As far as I know they pretty much develop their videos on student/audience demands.
 
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