Question

El Capitan Foods has a capital structure of 37% debt and 63% equity, its tax rate is 35%, and its beta (leveraged) is 1.45. Based on the Hamada equation, what would the firm's beta be if it used no debt, i.e., what is its unlevered beta, bU?1.050.731.240.860.80

Answer 1

1.050

Step-by-step explanation:

Data provided in the question:

Debt = 37% = 0.37

Equity = 63% = 0.63

Tax rate = 35% = 0.35

levered beta = 1.45

Now,

Using the Hamada equation

Levered beta = Unlevered beta × [ 1 + (1 - tax rate) × Debt-equity ratio ]

Thus,

1.45 = Unlevered beta × [ 1 + (1 - 0.35 ) × ( 0.37 ÷ 0.63 )]

or

1.45 = Unlevered beta × [ 1 + 0.65 × ( 0.37 ÷ 0.63 )]

1.45 = Unlevered beta × 1.382

or

Unlevered beta = 1.049 ≈ 1.050

Hence,

The answer is option 1.050