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I have a question:
A firm has an equity beta of 1.45 and is financed by 30% debt and 70% equity. It is split into 2 divisions of equal size: one division produces furniture and the other produces luxury wallpaper. The wall paper division is seen as 50% more riskier than the furniture division.
I want to find the asset beta of the furniture division (i.e i want the measure of business risk for the furniture division only)
How can i do that? please help.
Thanks in advance
First of all calculate the asset beta for the firm (using the formula on the formula sheet).
Then use a bit of easy algebra. The total asset beta of the firm will be equal to the weighted average of the asset betas of the individual divisions.
So…..if the asset beta of furniture is X, then the asset beta of wallpaper is 1.5xX(50% more risky)
The weighted average is (0.5 x X) + (0.5 x 1.5X) and this is equal to the asset beta of the whole firm.
You should then be able to calculate X 🙂
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