ACCA Strategic Professional · Advanced Financial Management · Discounted cash flow techniques
A firm has an equity beta of 1.20 when geared with debt-to-equity of 1:3 by market value. Debt beta is zero and tax is 25%. Using the Modigliani-Miller formula with tax, what is the asset (ungeared) beta, to two decimal places?
The asset beta is 0.96. With zero debt beta, ungearing uses equity beta times E divided by E plus D(1 - tax): 1.20 x 3 / (3 + 0.75) = 0.96.
- A0.96Correct
- B0.98
- C0.92
- D1.20
Explanation
βa = βe x E/(E + D(1-T)) = 1.20 x 3/(3 + 1 x 0.75) = 3.6/3.75 = 0.96. Ignoring tax would give 1.20 x 3/4 = 0.90, not an option, and 1.20 ignores gearing.
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