Question

The cost of equity for RJ Corporation is 8.4 percent and the debt-equity ratio is .6. The expected return on the market is 10.4 percent and the risk-free rate is 3.8 percent. Using the common assumption for the debt beta, what is the asset beta?

.62

.70

.67

.59

.44

Answer 1

We first need to compute equity beta:

Cost of equity = Rf + (Rm- Rf) x Equity Beta

                8.40% = 3.80% + (10.40% -3.80%) x equity beta

                Equity beta = (8.40% -3.80%) / 6.60%

                                       = 0.6970

We have following formula for Asset Beta

Asset Beta = Equity Beta / (1+ D/E ratio)

                     = 0.6970 / (1+0.60)

                     = 0.4356

Therefore, Asset beta would be 0.4356.