General idea: Risk which comes from the pension plans asset allocation should be included in the balance sheet in order to truly reflect the risk of the company (pension assets are shareholders assets and pension risks are corporate risks so they should be clearly shown)
By not including them we are:
1. Assigning the firm’s total risk to its business operations only, when a potentially significant part of that risk comes from the pension fund assets
2. Because the standard analysis does not take account of the pension liabilities, it understates the firm’s leverage ratio
So our problem is:
To make capital budgeting decision we need to estimate expected cash flows and discount those at firm’s WACC, so we understand that if that number (WACC) is distorted then decisions will also be distorted!
Typical effect is: WACC is overstated and we apply a high hurdle rate to projects so we may miss projects that will increase our company’s value!
Its calculation:
WACC is equal to : Rf + β of operating assets(ERP)
So our only problem is finding this β as other two should be given so we have to remember this formula:
Operating asset beta = TWO (just remember the number!)
Operating asset beta = (Total asset beta – Weighted pension beta)/Operating assets weight
And then apply the operating asset beta in WACC = Rf + β of operating assets(ERP)
And finally two classic cases:
1. Equities beta in pension assets is higher than firm’s balance sheet assets so total asset beta should be higher in evaluating projects and in order to keep the same equity beta as before we have to decrease debt so D/E ratio will decrease
2. Equities beta in pension assets is lower than firm’s balance sheet assets so total asset beta should be lower in evaluating projects and in order to keep the same equity beta as before we have to increase debt so D/E will increase |
发表于 2011-7-13 17:18
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