Allocating shareholder capital to pension plans assets, depends, balance, capital, average

John10

Hi,

in the Schweser level III book2 page 64, it is said that "if the beta of the pension plan assets is less than the beta of the firm's balance sheet assets, the WACC using the weighted average asset beta is less than the WACC using the balance sheet assets alone".

This sentence is incorrect, in my opinion, for 2 reasons:
1) The WACC doesn't depend on the weighted average asset beta, but on the operating assets beta which depends on the weighted average asset beta.
2) Even if the pension plan assets beta is higher than the balance sheet asset beta, the WACC can be lower when taking into consideration the size of the pension liabilities.

What's your opinion ?

Thanks in advance,

Bernard

IAmNeil

I do agree with you, except for your formula which should be:

Total Asset Beta = (Equity/Total Assets)*Equity Beta

I have no problem with the calcultation, but with the schweser definitions which are in my opinion unprecise.

By the way, I have another question. Why do we use the operating Beta for calculating the WACC ? In my comprehension the operating Beta is the Equity Beta "unleveraged". In other words, we do not take care of the amount of debt.
However by definition the WACC is the cost of capital (equity AND debt) and can becalculated as : Wd*Kd + We*Ke (=>we take into account the amount of debt)

justin88

Bern:

actually, it has taken account of the amount of debt. the hypothesis is that betas of the two sides of the balance sheets are equal.


CPEPIN is right.

Charles