FM300 extras?

Question 1

How do we find beta of debt?

Answer 1

Rd - rf / rm - rf

Question 2

Does cost of capital decrease when firms increase leverage?

Answer 2

When firms increase leverage, the cost of capital might initially decrease because debt is generally cheaper than equity, and interest payments are tax-deductible. This lower cost of debt can cause the overall Weighted Average Cost of Capital (WACC) to decline. However, as leverage continues to rise, the financial risk increases, which can lead to higher costs of both debt and equity. Beyond a certain point, the cost of capital may start to increase with higher leverage, offsetting the initial decline.

Question 3

When estimating the asset beta of a firm based on its peers, we can never estimate the assets beta. Instead we should Unlever and reliever?

Answer 3

False - if all peers have the same leverage ratios, capital strcture policies and costs of debt, we can average equity beta.