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October 17, 2015 at 9:15 am
Why do you upgear and why?
John Moffat says
October 17, 2015 at 9:33 am
We don’t “upgear”!
The beta of a share measures the risk of a share and part of the risk is due to the gearing. If we want to measure the risk of the actual business then we need to remove the affect of the gearing and calculate what the beta would be without gearing.
This is all explained in the lectures on CAPM. (I assume that you have watched all the earlier ones?)
If you still have problems with the idea then watch also the Paper F9 lectures on CAPM (because this is revision of F9)
October 16, 2015 at 9:24 pm
do I understand correctly that greater gearing increases systematic risk and therefore beta is increasing as well?
So greater the gearing >>>> greater systematic risk of a stock >>>> greater Beta >>>>>> greater Ke >>>>>> Greater WACC >>>>>> lower value of a company?
Is It also depends when WACC will increase due to gaering in accordance with MM and traditional theory as there are also capital structure issues?
October 16, 2015 at 9:55 pm
One more question Sir,
Increased gearing implies increased Vd >>>>>>>> Vd makes greater Beta Equity >>>>>>>> Greater Beta Equity makes greater WACC >>>>>>> once WACC is greater Ve is lower (in accourdance with say discounted FCF model)
My question is:
Once Ve became lower (and gearing has changed again) should we recalculate Beta Equity again? If it is the case it is becoming endless circle… How should we deal with that issue?
October 16, 2015 at 10:06 pm
and where do we get Ve initially if the company is unquoted?
Sorry that I ask a lot of question if they are irrelevant or out of P4 scope may be there is no need to answer them…
October 17, 2015 at 9:36 am
More gearing increases the beta of the share and therefore increases the cost of equity.
However this does not mean that the WACC will increase because more gearing also means more debt and the cost of debt is lower than the cost of equity. As you will remember from earlier lectures, according to M&M with tax, the WACC will fall with higher gearing.
October 17, 2015 at 9:37 am
If the company is unquoted then certainly we do not know Ve.
In an exam you will either have to be given a value or given the gearing ratio.
(We can however find the asset beta by taking a similar quoted company and angering their equity beta using their gearing)
October 17, 2015 at 11:21 am
Thank you sir, now rewatching F9 lecture relating to MM and capital structure.
For those who not sure regarding effect of gearing I recommend to watch this lecture regarding MM and Traditional gearing theory first…
but anyway I want to confirm my understanding:
Beta = Standard deviation of systematic risk of a company/ Standard deviation of systematic risk of a Market.
We assume that systematic risk of a Market is fixed. So beta can be greater only in case if systematic risk of a company is greater. Once gearing increases Beta does it imply increasing in systematic risk? Otherwise how can we make beta greater due to gearing in accordance with above formula?
October 17, 2015 at 3:33 pm
Gearing increases all the risk in a share, but it is only the systematic risk that we are concerned about.
October 17, 2015 at 3:35 pm
July 3, 2015 at 12:15 pm
Just a bit confused. “published betas are betas of a share”. Does betas of a share mean Equity beta?
Equity betas are betas showing the gearing effect along with the systematic risk of a share. And to show the business risk only, which is systematic risk, the equity beta needs to be ungeared ( which is the asset beta). Am I right?
July 3, 2015 at 4:18 pm
Yes – the betas of shares are the equity betas.
And yes about the gearing also 🙂
July 3, 2015 at 4:31 pm
Thank you!! 🙂
July 3, 2015 at 4:33 pm
And is it ok to ask qns relating to the lectures right here or should it be asked inn ask the tutor forum?
July 4, 2015 at 10:23 am
If the question relates directly to the lecture, then here is OK.
Better though is Ask the Tutor 🙂
May 20, 2014 at 2:02 pm
Great great thanks!. Makes sense after reading the lines carefully.lol
May 20, 2014 at 11:31 am
Just thinking that at what point do we now need to regear when appraising a project as example 11 only stopped at re-gearing
May 20, 2014 at 11:32 am
sorry i mean’t example 11 stopped at un-gearing.
May 20, 2014 at 11:42 am
If the examiner asks for a project specify cost of equity, he expects you to regear the beta and then calculate the cost of equity
May 20, 2014 at 1:28 pm
Ok thanks……….but re-gear using the company’s capital structure / the project intended capital structure?
Also,this lecture was able to break down the essence of ungearing.please can you help me out with the simplistic reason for re-gearing?
May 20, 2014 at 1:35 pm
We ungear a similar company to find the riskiness of the business and therefore the project (the asset beta).
To appraise the project we also need to take into account the gearing of the project (because the gearing in the project will make the equity more risky), so we need to regear the beta to get the equity beta.
If it is a normal NPV question, then we need to discount at the WACC. We usually assume that the gearing of the project will be the same as that currently existing in the company, so you regear the beta to get the equity beta. Use this to get the cost of equity. Then calculate a WACC for the project in the normal way.
If you are being asked for the APV, then regearing is not relevant (because the base case NPV assumes all equity and we are dealing with the gearing separately).
I hope that all makes sense 🙂
October 10, 2012 at 1:10 am
September 6, 2012 at 11:28 pm
April 5, 2012 at 7:23 am
The speed of current format is not as good as previous format. What should I do if I prefer to use previous format?
April 5, 2012 at 8:02 am
new format is actually more reliable, and you can watch it on your mobile.
what is your problem?
May 18, 2013 at 12:48 pm
HAHA HAHA! U got told!!!!
February 28, 2012 at 1:09 pm
July 26, 2011 at 6:56 pm
Going good. I am just refreshing my memory and I love this area.
May 11, 2011 at 11:17 pm
when appraising project when do we:
Ungeared and why?
ungeared and regeared and why ?
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