After calculating the asset beta for the ship building business why did we have to calculate the asset beta for X again as it was already given as 1.48?

good day sir
i am looking at a pass paper answer and this is what they did. i dont understand this part beta = 0·842 x (5Equity 7,280 + (5,171 x 0·7))/57,280 = 0·895

First, the proxy company equity beta must be ungeared:
Asset beta = (1·038 x 0·75)/(0·75 + (0·25 x 0·7)) = 0·842
The asset beta must then be regeared to reflect the financial risk of Card Co:
Equity beta = 0·842 x (57,280 + (5,171 x 0·7))/57,280 = 0·895
Project-specific cost of equity = 4 + (0·895 x 5) = 8·5%

Please ask this sort of question in the Ask the Tutor Forum in future – not as a comment on a lecture.

It is using the asset beta formula ‘backwards’ using the gearing of Card. We know the asset beta, we know the gearing, therefore we can use the formula to calculate the equity beta.

Thank you sir. Is it something you cover in P4?
Do you have any lectures on valuing a business by the net assets methods, P/E method or dividend growth method?

Dear John,
So in f9 it is fully assumed to be finance by equity, hence Ba, by ungearing. If its not share beta then we use simple beta and req return. If both not given these conditions, we use wacc ie to use grwoth model for equity and apply debt formulae as you taught.

I am going to amend the lecture slightly. When the examiner brought this into the syllabus a few years ago it was not quite clear what he intended. Now he has asked it twice it seems that he wants you to assume that the company is maintaining its current gearing.
So when he asks for the ‘project specific cost of equity’, he expects the following:
1) take the equity beta from a similar company and use the formula to calculate the asset beta (using the other company’s gearing to ungear it.
2) from this asset beta, use the formula again to calculate an equity beta, using the gearing of our company.
3) calculate the cost of equity from this equity beta – this is the ‘project specific cost of equity.

With regard to when to use the growth model and when to use CAPM, the examiner always makes it clear in the questions or only gives you information to be able to do it one way.
(In theory they would both give the same answer – in practice they do not and CAPM is regarded as being better)
For ‘project specific cost of equity’ it is always using CAPM.

Dear John, question.
I’m a bit confused, as you taught, the beta a we have is bets with no gearing(ie. entirely financed from equity), then why do we use the euity beta to get the project specific cost of equity? Shouldn’t we use the beta a directly?

sir
so, we assume in F9 all projects are equity finance
debt comes into place at p4
what is re-gear as u mention above and why do we need to do that?
clear me in simple words sir
because I have fully understand ur lecture video
but confuse with re-gear thing

We assume that we are maintaining the current level of gearing that exists in the company, not that it is all equity financed.

So the cost of equity is determined by the beta of the equity in the project, which is determined by the risk of the project together with the risk due to the gearing – i.e. the equity (re-geared) beta.

Funny thought, I wish you could be the minister of finance & economy in my country. I live in a an economically depressed country. I’m sure you’d make an awesome minister 😀

Thank you John,The topic was well explained,No need of memorizing as the topic was well understood.You are a teacher not a lecturer and i appreciate you for that.Also u did try as much as possible to simplify f9 which is very helpful. Cheers and keep up the good work,God Bless you.

Yes – if you are asked for the cost of equity then this is correct.

The cost of equity is always determined from the geared (equity) beta.

(although obviously if the company is all equity financed, or if the project is to be financed all from equity, then the geared beta will be the same as the ungeared (asset) beta. (

Arun says

Hi John,

After calculating the asset beta for the ship building business why did we have to calculate the asset beta for X again as it was already given as 1.48?

Thanks.

John Moffat says

We didn’t calculate it again – we calculated the equity beta from the asset beta using our companys gearing ratio.

Ruth says

Hi John

so how do we know when to assume “we are maintaining same gearing ratio” and when to assume “all equity financed”???

John Moffat says

Usually we assume the gearing ratio is maintained and therefore use the WACC to appraise.

The only time we do different (in Paper F9) is when we are asked for a project specific cost of equity.

Ruth says

Thanks John

ricardo says

good day sir

i am looking at a pass paper answer and this is what they did. i dont understand this part beta = 0·842 x (5Equity 7,280 + (5,171 x 0·7))/57,280 = 0·895

First, the proxy company equity beta must be ungeared:

Asset beta = (1·038 x 0·75)/(0·75 + (0·25 x 0·7)) = 0·842

The asset beta must then be regeared to reflect the financial risk of Card Co:

Equity beta = 0·842 x (57,280 + (5,171 x 0·7))/57,280 = 0·895

Project-specific cost of equity = 4 + (0·895 x 5) = 8·5%

John Moffat says

Please ask this sort of question in the Ask the Tutor Forum in future – not as a comment on a lecture.

It is using the asset beta formula ‘backwards’ using the gearing of Card. We know the asset beta, we know the gearing, therefore we can use the formula to calculate the equity beta.

fahim231 says

hello sir please help me on this

How do you re gear the beta to the company’s own debt to equity ratio?

John Moffat says

You use the asset beta formula ‘backwards’. You know the asset beta and you use the company’s own gearing.

fahim231 says

Thank you sir. Is it something you cover in P4?

Do you have any lectures on valuing a business by the net assets methods, P/E method or dividend growth method?

Thanks again

John Moffat says

It is covered in P4, although I will add another lecture to F9 in the next few weeks dealing with it.

Chapter 15 and 16 of our free Lecture Notes (and the lectures that go with them) cover what is required in F9 for valuation.

(Our notes and lectures are a complete course and should be watched in order)

acca2050 says

Dear John,

So in f9 it is fully assumed to be finance by equity, hence Ba, by ungearing. If its not share beta then we use simple beta and req return. If both not given these conditions, we use wacc ie to use grwoth model for equity and apply debt formulae as you taught.

John Moffat says

I am going to amend the lecture slightly. When the examiner brought this into the syllabus a few years ago it was not quite clear what he intended. Now he has asked it twice it seems that he wants you to assume that the company is maintaining its current gearing.

So when he asks for the ‘project specific cost of equity’, he expects the following:

1) take the equity beta from a similar company and use the formula to calculate the asset beta (using the other company’s gearing to ungear it.

2) from this asset beta, use the formula again to calculate an equity beta, using the gearing of our company.

3) calculate the cost of equity from this equity beta – this is the ‘project specific cost of equity.

With regard to when to use the growth model and when to use CAPM, the examiner always makes it clear in the questions or only gives you information to be able to do it one way.

(In theory they would both give the same answer – in practice they do not and CAPM is regarded as being better)

For ‘project specific cost of equity’ it is always using CAPM.

acca2050 says

amazing

rick says

Dear John, question.

I’m a bit confused, as you taught, the beta a we have is bets with no gearing(ie. entirely financed from equity), then why do we use the euity beta to get the project specific cost of equity? Shouldn’t we use the beta a directly?

John Moffat says

If were only using equity to finance the project then you would be correct.

However in Paper F9 the examiner expects you to assume that we are maintaining our existing gearing ratio and therefore need to re-gear the beta.

Ashwin says

sir

so, we assume in F9 all projects are equity finance

debt comes into place at p4

what is re-gear as u mention above and why do we need to do that?

clear me in simple words sir

because I have fully understand ur lecture video

but confuse with re-gear thing

Ashwin says

And why we need to take into account our gearing ?

if we are doing a different project

clear me on these points sir

John Moffat says

We assume that we are maintaining the current level of gearing that exists in the company, not that it is all equity financed.

So the cost of equity is determined by the beta of the equity in the project, which is determined by the risk of the project together with the risk due to the gearing – i.e. the equity (re-geared) beta.

Mamoon says

Master John ! Thank you so much, the test was easy thanks to you !

John Moffat says

That’s great – I am glad that the exam went well.

Mamoon says

Funny thought, I wish you could be the minister of finance & economy in my country. I live in a an economically depressed country. I’m sure you’d make an awesome minister 😀

John Moffat says

I am not so sure about that

iluvgorgeous says

these lectures are amazing. I can tell from the lectures that you put your heart and soul into it. Thank you sir

John Moffat says

Thank you

sonria says

I concur… May god continue to bless you sir

mahoysam says

Lovely job with those lectures! It is all very clear and interesting!

Thank you!

Maha

ogadiosondu says

Thank you John,The topic was well explained,No need of memorizing as the topic was well understood.You are a teacher not a lecturer and i appreciate you for that.Also u did try as much as possible to simplify f9 which is very helpful. Cheers and keep up the good work,God Bless you.

John Moffat says

Thank you very much

ummyrahma says

Does it. Mean in f9 you will not be required to ungear and regear .u only ungear and then use it to find the cost of equity. Is this wat u mean

John Moffat says

You can be asked to ungear, and then to regear for the gearing of the particular company.

hasanali95 says

Hi sir when do we ungear and re gear instead of just using the ungeared beta in CAPM formula?

John Moffat says

If we are using beta to calculate the cost of equity, then we need the geared beta because that measures the riskiness of the share itself.

papiasu says

Thank you sir, you are simply the best

John Moffat says

Yes – if you are asked for the cost of equity then this is correct.

The cost of equity is always determined from the geared (equity) beta.

(although obviously if the company is all equity financed, or if the project is to be financed all from equity, then the geared beta will be the same as the ungeared (asset) beta. (

hasanali95 says

So sir this sort of question cant come ryt?cz we only get questions which will be fully financed by equity and hence no gearing??

John Moffat says

Not true. You can be asked to calculate the equity beta from the asset beta – so that you can calculate the cost of equity for a geared company.

icriosphinx says

In the bpp study text. They un-gear the beta and re-gear it according to current company and then use it in the formula to get cost of equity…

superacca says

Thank you for the explanation on the Discount rate to use for the exam question

funlover says

This is surely a class act!

My only wish is to have a lecturer like you when I do P4.

Saad Bin Aziz says

@funlover,

p4 ! yes john we need you!