Asset Beta capital, only, structure, understand

Mechanic

The asset beta of a firm equals its equity beta if:
a. the company has no debt
b. the company has no equity
c. the company's debt equals its equity

The correct answer was A).
The formula for the asset beta is:

Asset Beta = Equity Beta (1/(1+((D/E)(1-t)))
Therefore, the two betas are identical only if the company has no debt in its capital structure (D = 0). If the company has no debt, then the asset beta must equal the equity beta.

I don't understand why the answer cannot also be B (E=0)?

Thanks!

dotamasta

Uh, debt magnifies (levers) equity beta as a multiple of asset beta, so lim(E->0) EquityBeta -> infinity.

So b doesn't work.



Edited 2 time(s). Last edit at Wednesday, November 24, 2010 at 12:21AM by bchadwick.

johnnyBuz

the assumption is that the denominator (E) cannot be zero

kmf229

If you try lim(E->0), B(asset)->0.

Similarly, as you said, B(eqty x)=cov(x,m)/(sigma(m)^2)->0 as E->0.

Thus, it looks to me that (b) should be accepted, too.

amqata

Well - to think about it, that would still make asset beta equal to equity beta didn't think about it but got the answer correct

agulani

Any other thoughts? I'm still confused.

JPSem

Logically, If the firm has no equity, what is equity beta?