Here bL is the firm's levered beta where the firm has debt in its capital structure, bU is the unlevered beta where there is no debt in the firm's capital structure, T is the corporate tax rate, and D/E is the measure of the firm's financial leverage at the current levered beta. The calculated levered beta bL is then substituted into the CAPM equation and the firm's cost of equity is calculated. Beta is the only variable in the CAPM equation that -Select-isisn'tItem 7 under the firm's control—as the risk-free rate and the market risk premium are determined by -Select-company actionsmarket forcesinvestor actionsItem 8 . Note that a firm's cost of equity can be broken down into the following components:
rs = rRF + Premium for business risk + Premium for financial risk
The -Select-GordonCAPMHamadaItem 9 equation can be rewritten to determine the unlevered beta, bU, which is a measure of the firm's basic -Select-financialbusinessmarketItem 10 risk. This equation is as follows:
bU = bL/[1 + (1 – T)(D/E)]
Give the correct response to the following question.
A firm's unlevered beta must be greater than its levered beta. True or false?
-Select-TrueFalseItem 11