Final answer:
EZCube's asset beta is calculated by weighing the equity beta and the debt beta by their respective financing proportions (50% each) to get an asset beta of 0.7. Furthermore, bonds and bank loans are forms of debt financing that impose different flexibility levels, trading options, and terms. Fred and Eva each have $20,000 equity in their homes, having put down 10% on a $200,000 house and borrowing the rest.
Step-by-step explanation:
The question posed is about calculating the asset beta for EZCube Corp. To find the asset beta, we weigh the equity beta and the debt beta by their respective proportions in the company's financing. EZCube Corp. is financed 50% by long-term bonds with a beta of 0.15 and 50% by common equity with a beta of 1.25. Therefore, the asset beta is calculated as follows:
Asset Beta = (Equity Proportion × Equity Beta) + (Debt Proportion × Debt Beta)
Asset Beta = (0.50 × 1.25) + (0.50 × 0.15)
Asset Beta = 0.625 + 0.075
Asset Beta = 0.70
Thus, EZCube's asset beta is 0.7, correct to one decimal point.
Regarding the self-check questions, very small companies tend to raise money from private investors instead of through an IPO because of the high costs and complexities associated with an IPO that are often not suitable for small, less-established firms. Small, young companies may prefer an IPO to borrowing from a bank or issuing bonds because an IPO can provide a large influx of capital, create a public market for the company's shares, and enhance its visibility and credibility. A venture capitalist likely has better information about whether a small firm is likely to earn profits compared to a potential bondholder because venture capitalists typically engage in more in-depth due diligence and often become directly involved with the management of the firms they invest in.
From a firm's perspective, a bond is similar to a bank loan in that both are forms of debt financing, requiring periodic interest payments and the eventual repayment of the principal. They differ in that bonds are typically traded on the open market, which can provide more flexibility, while bank loans are agreements between the borrower and the lender with less standard terms and conditions.
To calculate the equity in their homes:
- Fred's or Eva's home equity = House value - Amount borrowed
- Fred's or Eva's home equity = $200,000 - $180,000 (as they borrowed 90% of the home value)
- Fred's or Eva's home equity = $20,000