Discuss why Rusere Investments’ equity beta increases in response to the Pension Plan’s change in the asset allocation.

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Rusere Investments is a RSA based chain of department stores with operating assets of 1 billion (Rands) in market value terms. Rusere Investments sponsors a defined-benefit pension plan (Pension Plan) that invests exclusively in domestic equities and domestic investment grade corporate bonds. Selected Rusere Investments and Pension Plan financial data are shown in Exhibit 1. Exhibit 1 Rusere Investments (excluding Pension Plan) Measure Value Debt to equity ratio (market value) Operating assets market value (Rands billion) Equity beta Debt beta 0.6 1.0 1.9 0.0 Pension Plan Measure Value Equity portfolio beta 1.4 Debt investments beta 0.0 Market value (Rands million) Equity allocation (%) Surplus (Rands million) 700 60 0.0 Rusere Investments hires Reuel Tavongalshe to study the implications of the asset allocation of the Pension Plan's investment portfolio on Rusere Investments' financial and operating characteristics. Tavongalshe notes that a defined-benefit pension plan's assets and liabilities can directly affect the sponsoring company's equity price, the equity price volatility, and the amount of operational risk the company is able to assume. The nominal risk-free rate of return is 7.7% and the market return is 10%. Tavongalshe's preliminary analysis does not take the effects of taxes into consideration. Rusere Investments bases its capital budgeting decisions on the internal rate of return (IRR) and accepts capital projects with IRR greater than Rusere Investments' weighted average cost of capital (WACC). Rusere Investments does not include the Pension Plan's assets and liabilities when calculating its WACC. Rusere Investments is a RSA based chain of department stores with operating assets of 1 billion (Rands) in market value terms. Rusere Investments sponsors a defined-benefit pension plan (Pension Plan) that invests exclusively in domestic equities and domestic investment grade corporate bonds. Selected Rusere Investments and Pension Plan financial data are shown in Exhibit 1. Exhibit 1 Rusere Investments (excluding Pension Plan) Measure Value Debt to equity ratio (market value) Operating assets market value (Rands billion) Equity beta Debt beta 0.6 1.0 1.9 0.0 Pension Plan Measure Value Equity portfolio beta 1.4 Debt investments beta 0.0 Market value (Rands million) Equity allocation (%) Surplus (Rands million) 700 60 0.0 Rusere Investments hires Reuel Tavongalshe to study the implications of the asset allocation of the Pension Plan's investment portfolio on Rusere Investments' financial and operating characteristics. Tavongalshe notes that a defined-benefit pension plan's assets and liabilities can directly affect the sponsoring company's equity price, the equity price volatility, and the amount of operational risk the company is able to assume. The nominal risk-free rate of return is 7.7% and the market return is 10%. Tavongalshe's preliminary analysis does not take the effects of taxes into consideration. Rusere Investments bases its capital budgeting decisions on the internal rate of return (IRR) and accepts capital projects with IRR greater than Rusere Investments' weighted average cost of capital (WACC). Rusere Investments does not include the Pension Plan's assets and liabilities when calculating its WACC.

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