1. avatar says

    Dear Tutor,

    Please what if we are are an Oil company and we were going to invest in a Ship project, hence which means the business risk may be different from that of the company. The project will be all Equity financed and the current WACC is 10%. We were also given a similar company’s data in the shipping business. BUT Finally, the examiner drops a bomb and say after careful analysis, the company found out that taking on the project will not change the existing risk of the company.

    In this case above, what should be the discount factor to use?

    • Profile photo of John Moffat says

      It would be impossible for the examiner to do this. The only way that the existing risk would not change would be if oil carried the same risk as ships. If that were the case then using the asset beta for ships would still be the right approach (because the asset beta for oil would be the same)

      If you see a question and you think he is doing this, then I really would read again very carefully :-)

      PS If you are asking questions of me, then it is better to ask in the Ask the ACCA tutor forum for P4. It is not always possible to check all the comments made below lectures – there are so many lectures – but questions in the Ask ACCA Tutor forums are always checked and answered.

  2. avatar says

    I HAVE UNDERSTOOD THOUGH I MUST ADMIT ONE THEN NEEDS TO PAY PARTICULAR ATTENSION TO THE GEARING RATIO. That you need to understand like in the example above that when he says gearing ratio (debt to equity) of 0.4, it doesn’t mean 40% debt and 60% equity. I mean that was my initial confused assumption Admin. which would have also been in the exam too!

  3. avatar says

    I’m not sure about one thing…In Example 11 the asset beta equals to 1.57, equity beta is 1.80. What about the difference of 0.23? What does it represent if we assume that debt beta is 0?

    • Profile photo of John Moffat says

      Gearing makes the shares more risky and therefore the equity (share) beta is greater than the asset beta (which is the risk if there was no gearing). The fact that we assume the debt beta to be zero is irrelevant in that more gearing will always make a share more risky.
      There is no special significance attaching to the difference of 0.23.

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