BSAS Mock exam Q5 AM session through, sequence, question, long

jbaldyga

Hi guys,

Reference is Reading 22 in the CFA textbooks - Allocating Shareholder Capital to Pensions (WACC)

Bear with me guys, I'm writing down my understanding of the questions. It's a little long but please bear with. My question comes in 3)

Going through the textbooks and the BSAS exam Question 5 g), they typical sequence of questions goes like this:

1) Unlevered Betas with no pension assets
Given: Equity Beta, risk free, risk premium
Calculate: "unlevered" Total Asset beta = equity /T. Assets x Beta Equity (regressed)
Use to Calculate WACC

2) Add pension assets to Balance Sheet to back out new Beta Operating
Calculate Pension assets: % invested in stock x 1.0
Calculate Total Asset Beta: (equity / (operating assets + pension) x Beta Equity
Total Asset Beta = (Beta Operating x weight of operating) +(Beta Pension x weight of pension)

Back-out Beta Operating by rearranging the above and use to calculate WACC

3) Now, change allocation of equity in pension assets (eg. 60% stock --> 70% stock)

THIS is where I'm getting confused as hell. The CFA text (page 478-479) and the BSAS calculates the #s differently.

In the CFA text the sequence goes like:
KEEP Beta Operating constant (the Beta Operating calculated from 2) above) and change the right side of the Total Asset Beta formula. This will just change the rightmost bracket to get Total Asset Beta.
You then use this Total Asset Beta to calculate Firm Equity Beta

In the BSAS exam the sequence goes like:
KEEP Beta Operating constant BUT use the Beta Operating (unlevered) from 1)!

WTF is going on here, and which do we use??? This is driving me nuts.