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5 years ago
Trucks R' Us has a market capitalization of $142 billion, $78 billion in BB rated debt, and $10 billion in cash. If Trucks R' Us' equity beta is 1.68, then their underlying asset beta is closest to:
A) 1.00
B) 1.20
C) 1.32
D) 1.48
Textbook 
Corporate Finance: The Core

Corporate Finance: The Core


Edition: 4th
Authors:
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anicidanicid
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B
Explanation:  B) We can think of Trucks R' Us business assets as a portfolio of equity, plus debt, and less cash.  Assuming the beta of cash investments is zero:
βU =  βE +  βD +  βC
   =   × 1.68 +   × 0.17 -   × 0.0
   = 1.199
Alternatively, we estimate asset beta based on its net debt of 78-10=68 m.  Using net debt:
βU =  βE +  βD
   =   × 1.15 +   × 0.17
   = 1.191
Note that both answers are quite similar.  The second approach presumes that TRU's cash reduces the average market risk of its debt (as thought TRU used its cash to repay its senior debt).
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