bkballa

Most important thing to remember at the start is they are defining WACC = Rf + Beta of Operating Assets (Market Risk Premium)

For the rest:
Rf = Risk Free
Boa = Beta Operating Assets
Bta = Beta Total Assets
Bp = Beta Pension
Be = Beta Equity
OA = Operating Assets
PA = Pension Assets
MRP = Market Risk Premium
E = Equity
L = Liability

Ok, sorry about that long list but it can be hard to post clear equations on AF.

So Wacc w/no Pension:
1. Solve for Boa = E/(L+E) x Be
2. Wacc = Rf + Boa(MRP)

Now bring Pension into the mix.
1.Add Pensions Assets and Liabilities (add to both sides of the balance sheet)
2. Solve for Bta = E/(L+E) x Be (remember the L should have increased in all of the below)
3. Solve for Boa (I back into it...thus the *Boa* is what you solving for), yes you could rearrange, but I just find it easier to remember this way.

Bta(we just calculated in #2) = OA/(L+E) x *Boa* + PA/(L+E) x Bp
Thus the Bta is just a weighted average of OA times its Beta and Pension Assets times its Beta (Bp will be given). It is this new Boa that you've been working towards.

4. Once you have that Boa from step 3:
Wacc = Rf + Boa(MRP).

bkballa

1morelevel Wrote:
-------------------------------------------------------
> If you reallocate more to the pension equity, the
> firm risk has increased and its stock will be more
> volatile. So with all else being equal, equity
> beta would increase.
>
> I think what you are remembering from the book is
> the chart that showed the required change in the
> capital structure needed to OFFSET the changes in
> pension assets to maintain the equity beta.
>
> For instance, if they rebalance to more equity in
> the pension, the company would need to delever, ie
> pay down debt or raise equity to maintain the
> equity beta at the same level.
>
> Vice versa if they allocated more pension assets
> to fixed income, the firm risk would decrease and
> equity beta would fall. If they wanted to
> maintain the equity beta, they should add more
> risk to the operating balance sheet, ie buyback
> stock or issue more debt.


That is what I mean, I view this is a swift process, you don't want to let the equity beta change, so asset beta is the one to change.