Am I Missing Something or is CFA book Incorrect? something, believe, example, problem, someone

ikoreaii

Example 13, on CFA Volume 4, Reading 45, page 64
I can’t solve the Betas on Table 5 using the pureplay method cause there is no mentioning of the debttoequity ratio. The example only list the debttocapital ratio which I believe is not a variable to solve for the leveraged beta. Am I missing something?
Also, I’m having a problem solving for the WACC in Table 5 as well.
Appreciate it if someone can explain.

Mechanic

Capital equals debt + equity. Given debt to capital you can solve for debt to equity.

Palantir

DTM,
The problem is the book provides a flat rate for the debttocapital ratio. For example it lists debttocapital is .50
I don’t see how I can solve for debt to equity unless they provide a breakdown of values for debt or equity

brainsX

if wondering, check cfai’s errata web page.

agulani

Checked and the errata page did not state anything on this reading….

Iginla2010

I’d appreciate this DTM86, please let me know what you think of Table 5

dyga

Which part are you having trouble with? I’ll go ahead and provide what is hopefully a helpful explanation for each column.
D/D+E is just given for you to solve and I’ll refer to as D/A below.
Beta: You are given the unlevered beta of 0.9. Using the D/A to get to D/E by doing [D/A / (1D/A)] and then you can solve for Beta by using the formula = Bu * [1+D/E*(1tax)]
Cost of debt: they give you the base rate of 4.5% which you apply a spread to as given in the table above for different levels of debt. 100bps = 1% so as an example at a D/A of .4 the spread is 300bps so 4.5%+3%=7.5%
Cost of equity: Use CAPM. You just found the levered betas and they give you the risk free rate and market risk premium. Re=Rf+Beta*MRP
WACC: Use all the other inputs you just found: WACC=Re*(1D/A)+Rd*D/A*(1tax)
The optimal capital structure is at 30% debt because WACC is minimized

joemoran

Thanks DTM,
I was having trouble calculating Beta for each D/D+E or D/A as you called it.
Reason was that the book normally indicates D/E (debt to equity ratio) to calculate asset or equity beta. This example specifically indicated D/D+E (debt to total capital ratio).
So I guess you can convert debt to capital ratio to debt to equity by dividing debt to captital ratio by 1  Debt to capital ratio? How’d you figure that out?

waldziuchna

DTM,
After taking a second thought and looking at this again, i realize the concept is simpler that how i just described it above.
If Debt/(Debt + Equity) = .70
so
Debt/Equity = .70/.30
Thanks again for your help!

marsilni

Exactly! That’s what I meant above as well with the .5/.5=1 example. Glad i could help