Question

Assume a firm is financed with $7500 debt and $2500 equity. The beta of the equity is 1.1. The risk-free rate is 3%, and the equity premium is 6%. If the overall cost of capital of the firm is 8%, what is the beta of the firmʹs debt?

0.74

0.14

0.28

0.92          

Answer 1

Beta of Firm's Debt = 0.74

Please refer to below spreadsheet for calculation and answer. Cell reference also provided.

B C D Capital Debt Equity Amount 7500 2500 10000 Weight 0.75 0.25 WACC Risk free rate Equity premium(Market Premium) 8% 3% 6% Beta of equity Cost of equity 1.1 9.6% 12 13 14 Cost of debt Beta of Debt 7.47% 0.74

Cell reference -

B C D Capital Debt Equity Amount 7500 2500 =SUM(C3:04) Weight =C3/$C$5 =C4/$C$5 WACC Risk free rate Equity premium(Market Premium) 0.08 0.03 0.06 Beta of equity Cost of equity 1.1 =C8+C11*09 Cost of debt Beta of Debt =(C7-C12*D4)/D3 =(C14-C8)/C9

Hope this will help, please do comment if you need any further explanation. Your feedback would be highly appreciated.