WACC schweser PE2 average, usually, represents, produces, assets

Wendy01

schweser PE2 P.53 12.2

the answer says,

"the weighted average asset beta for the plan, assuming debt securities have zero beta,
is usually less than that for the sponsoring firm's operating assets, so combining the firm's and plan's assets usually produces a lower WACC."

plan's beta is usually less than firm's operating beta ?
Is this usually the case ?

CFAI R22 Table3 represents
"operating assets beta is 0.36, while pension assets beta is 0.60..."

Colum

manet_5 Wrote:
-------------------------------------------------------
> schweser PE2 P.53 12.2
>
> the answer says,
>
> "the weighted average asset beta for the plan,
> assuming debt securities have zero beta,
> is usually less than that for the sponsoring
> firm's operating assets, so combining the firm's
> and plan's assets usually produces a lower WACC."
>
> plan's beta is usually less than firm's operating
> beta ?
> Is this usually the case ?
>
> CFAI R22 Table3 represents
> "operating assets beta is 0.36, while pension
> assets beta is 0.60..."


Yes; plan beta is usually less than firm op. beta b/c plan typically holds more fixed income securities than equity.

liangfeng

Yes because when accounting for pension assets, total debt increases but equity is the same.

Windjam

Think he is talking about asset beta

infinitybenzo

manet_5 Wrote:
-------------------------------------------------------
> thanks all!
>
> One more thing;
>
> Is WACC calculated using OPERATING assets beta or
> TOTAL asset beta(including pension assets) ?

Either. Usually Operating Asset Beta, although point of LOS 22.b is that a WACC could be calculated on total asset beta, which *usually* results in a lower WACC. The market usually considers the pension plan when evaluating the risk of the firm.

> The matter is that OPERATING asset beta decreases
> including pension asset,
> even when pension asset beta(weighted average of
> equity and debt) is higher than operating asset
> beta ?

Don't confuse LOS 22.b with LOS 22.c. The former is holding operating asset beta fixed and showing that if pension asset beta is lower (higher) than operating asset beta, then WACC calculated on operating assets alone is overestimated (underestimated).

LOS 22.c shows that if operating asset beta is fixed *and* we want to hold equity beta constant, the greater (lesser) the pension asset beta, the lower (greater) the debt ratio of the firm is required.

>
> TOTAL asset beta(weighted average of operating
> asset beta and pension asset beta) doesn't matter
> ?

Sure it does. As mentioned before, the market considers the total risk, inclusive of pension assets.

Roflnadal

#1. Are you reading CFAI texts? these questions are pretty much directly answered in the book in reading 22.

#2. The asset Beta is normally lower when incorporating pension assets b/c most pension assets are still funded using traditional risk mgmt techniques which increase the risk of being underfunded. when liabilities are greater than assets, the result is like the firm is borrowing from their pension plan to fund operations. this borrowing is what decreases the asset beta and lowers the WACC.

When pension liabilities are linked with assets the plan stays more properly matched (ie funded) this lessens the risk of the plan, and reduces the amount the firm "borrows" from the plan to fund operations. With a lower amount borrowed the firm has a greater proportion of its capital structure in equity, which increases the WACC.

I think this second part was not as well explained in the reading, but after going through this reading twice now, it's what I have taken away.

pennyless

A simple Balance Sheet table could be helpful for this kind of questions. Or a formula like:

Without Pension: OA*beta(OA) = E*beta(E)

Case I: beta(E) constant, if adding pension asset/liability, WACC=?

1) OA*beta1(OA) + PA*beta(PA) = E*beta(E)
2) beta1(OA) < beta(OA)
==> WACC1 is lower than the original WACC.

Case II: beta1(OA) and beta(E) constant, if beta(PA) increasing, D/E=?

1) OA*beta1(OA) + PA*beta(PA) = E*beta(E)
2) If beta(OA) increses, total asset beta increases, equity capial(E) increase,
==> D/E decreases. (D+E=OA)