Portfolio Management. www.Safeecollege.com2 24. Asset Beta and Equity Beta i)Asset of a firm are financed by Equity or Debt. Firm B/s Equity Asset Debt.

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Presentation transcript:

Portfolio Management

24. Asset Beta and Equity Beta i)Asset of a firm are financed by Equity or Debt. Firm B/s Equity Asset Debt ße Beta Equity ßd Beta Debt ßa Beta Asset ßa = Weighted Average Beta of Equity and Debt = ße E + ßd D In No Tax World E + D E + D Unless Otherwise Given in Question ßd = 0

ii. Tax world Formula Debt Instrument has advantage in the form of TSI (Tax Saving Instruments) The moment we go for debt fund this benefit comes in and we can measure it as Present Value of TSI. Assuming Debt is Perpetual we can get Present Value of TSI as under Interest = D × I TSI = D × I × T PV of TSI = D × I × T = D × I I D = Debt T = Tax Rate I = Coupon Interest Rate Discount Rate Opportunity Rate

PV of Perpetual Cash Flow = Cash Flow c Discount Rate r PV Growing Perpetual = c r - g g = Growth Rate We can now replace D with ( D – DT ) i.e D ( 1 – T ) Tax World When Debt is Perpetual and we get advantage of Tax on Debt then the value of Debt Reduces. Unless Otherwise given ßd = 0 then tax world formula reduces to : ßa = ße E E + D (1 - T)

ße = ßa D (1 – T) E Hemada Equation Practical Issue Relating to Asset Beta and Equity Beta Leavered Firm Financed By Debt and Equity Unleavered Firm Financed By Equity

i)Asset of a firm are financed by Equity (Unleavered) Firm B/s Equity Asset ße Beta Equityßa Beta Asset Cash Flow on Asset has nothing to do with Equity or the amount of Finance being done. If we know ßa than we can calculate Minimum Cash Flow of Asset. ßa ra minimum required return on asset ra = rf + ( rm – rf ) ßa ße = ßa Because Shareholder are having only one type of risk that is Systematic risk of asset.

ii) Asset of a firm are financed by Equity or Debt. Firm B/s Equity Asset Debt ße Beta Equity ßd Beta Debt ßa Beta Asset ße ≠ ßa Because Shareholder are having two types of risk that is Systematic risk and another is Finance Risk. ße = ßa D (1 – T) E

iii) Asset of a firm are financed by Equity or Debt. Firm B/s Equity Asset 1 Asset 2 Asset 3 ße Beta Equityßa Beta Asset ße = ßa Equal to Weighted Average Betas of Individual Asset

iv) Asset of a firm are financed by Equity or Debt. Firm B/s Equity Asset 1 Asset 2 Debt Asset 3 ße Beta Equity ßd Beta Debt ßa Beta Asset ße ≠ ßa Because Shareholder are having two types of risk that is Systematic risk and another is Finance Risk. Method 1: ßa = Weighted Average Betas of Individual Asset Method 2:

When Asset BETA Changes: When Asset Profile Change i.e. nature of business. When Equity BETA Changes: When Asset Profile Changes When Capital Structure Changes Expansion : Similar Business : BETA Asset Same Diversification : Different Business: BETA Asset Changes