Final answer:
To find Orion's new equity beta after increasing its debt to 56%, we would first calculate the unlevered beta using the original equity beta and capital structure, then apply the levered beta formula with the new debt-to-equity ratio considering the tax rate.
Step-by-step explanation:
The student is asking about the change in a firm's equity beta when its capital structure changes. Initially, Orion has a capital structure with 22% debt and the rest as equity, with an equity beta of 1.51 and a debt beta of 0. The question then posits a change in capital structure to 56% debt and asks for the new equity beta, given that the debt beta remains at 0 and the marginal tax rate is 22%.
To solve this, we can use the formula for the levered beta (beta of equity in a leveraged firm), which is given by:
BetaLevered = BetaUnlevered * [1 + ((1 - Tax Rate) * (Debt/Equity))]
In this scenario, we need to find the beta of the equity after the change in capital structure. We start by calculating the unlevered beta (beta of a firm without debt), which is not provided but can normally be found using the original equity beta and capital structure information. Once we have the unlevered beta, we can calculate the new levered beta using the new debt-to-equity ratio after the capital structure change:
New Debt-to-Equity Ratio = Debt Percentage / Equity Percentage = 56% / 44%
We insert these values into the levered beta formula to find the new equity beta.