Reading 22: Allocating Shareholder Capital to Pension Plan

following, maintain, framework, different, allocation

LOS c: Explain, in an expanded balance sheet framework, the effects of different pension asset allocations on total asset betas, the equity capital needed to maintain equity beta at a desired level, and the debt/equity ratio.

Q1. When the pension asset allocation changes which of the following is least likely to occur?

A) The higher the investment in bonds in the pension assets the more debt the firm will need to issue to maintain the same overall level of risk in the firm’s capital structure.

B) The equity beta will change while the total value of firm assets remains constant.

C) The total value of liabilities and equity stays the same even though the amount of equity capital changes.

Q2. Given the following partial balance sheet what would be the most likely values for the total asset beta, equity capital, and debt-to-equity ratio holding the equity beta constant assuming the pension assets are invested 50% in equities.

% of Pension Assets in Equities	Total Asset Beta	Equity Capital (?Millions)	Debt-to-Equity Ratio
0	0.19		4.5
50
100		40

A) Total asset beta > 0.19, debt-to-equity ratio < 4.5.

B) Total asset beta > 0.19, debt-to-equity ratio > 4.5.

C) Equity capital < 40, debt-to-equity ratio > 4.5.

Q3. If a company changes its allocation of pension assets to be invested more heavily in bonds while maintaining the same equity beta, what is the likely effect on the:

Total asset beta? Debt/equity ratio?

A) Decrease Decrease

B) Increase Decrease

C) Decrease Increase

Q4. To maintain the same equity beta after decreasing the percentage of pension assets invested in equities a firm would need to:

A) increase the amount of risk in its capital structure by using more debt financing.

B) increase the amount of risk in its capital structure by using more equity capital.

C) decrease the amount of risk in its capital structure by using less equity capital.

Q5. A firm increases the risk of its pension assets by investing those assets in a higher percentage of equities. The amount of equity capital needed to maintain the same equity beta and the resulting debt/equity ratio respectively would:

Equity Capital Debt/Equity

A) Decrease Increase

B) Decrease Decrease

C) Increase Decrease