Question

Here is some data for three firms in the restaurant industry:

Firm #1: $100 million in debt, $200 million in equity, current estimated equity beta of 3.0

Firm #2: $200 million in debt, $200 million in equity, current estimated equity beta of 3.0

Firm #3: $300 million in debt, $100 million in equity, current estimated equity beta of 4.0

There are no corporate or personal taxes   

(a) For each firm, calculate Beta unlevered

(b) Using your answer in part (a), what would you predict the equity beta to be for a firm in the restaurant industry with $300 million in debt and $600 million in equity?

The answers are (a) Firm 1= 2, Firm 2 = 1.5, Firm 3 = 1 (b) 2.25 but please show how to get these answers.

Answer 1

Equity beta is the measure of price sensitivity of equity stock with market portfolio. In other words beta measure change in price of equity due to $ 1 change in market portfolio price.

Equity beta can be classified into two types -

1. Levered Beta - It considered Debt of company while calculating Levered Beta
2. Unlevered Beta - It doesn't considered Debt of company while calculating unlevered Beta

a)

Firm#1

Firm#2

Firm#3

b)

A Firm with $ 300 million debt and $ 600 equity in restaurant industry has following levered equity beta -

Hope this will help, if you need any further explanation please comment.