P15.1 Levered Beta
If IBM had an upper-marginal tax rate of 40%, financed itself with 30% debt (relative to 70% equity),
and had an unlevered beta of 1.25. Also suppose that the prevailing risk-free rate is 4% and the return of
the market average is 10%.
a.) What is IBM’s levered beta?
b.) What is IBM’s unlevered cost of equity?
c.) What is IBM’s levered cost of equity?
d.) How much additional risk premium are investors requiring due to IBM’s additional, debt-based risk?
e.) Suppose that you were told the realized (levered) beta (from the marketplace) was 1.40, can you find
IBM’s (hypothetical) unlevered beta and, if so, what is it?
f.) How would increases in the following variables impact IBM’s equity costs?
i.] Unlevered beta
ii.] Upper Marginal Tax Rate
iii.] Weight of Debt
iv.] Wight of Equity