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When we calculate the beta asset for a new project we want to invest in, we un-gear the equity beta of the other company according to that company’s gearing ratio. Should we not then re-gear that beta asset we just calculated according to our own company’s gearing ratio in order to find the beta we will put in the capital asset pricing model formula to calculate the cost of equity? Why isn’t it re-geared in your lectures?
Certainly, to get the beta of the project we ungear the equity beta of a similar company using the gearing of that similar company.
When we come to using that beta, it really depends how the project is being financed. We should regear the beta depending on how we are financing the project. If the project were to be financed entirely from equity, then the beta does not need regearing.
However, in F9, we will normally assume that the project is being financed in the same way as the existing gearing of our company, and therefore – yes – on that assumption we would use the existing gearing of our company to regear the beta, and use this geared beta to arrive at a cost of equity for the project (and we would then use that to calculate a WACC for the project, but in F9 you are not asked to do this).
I had thought that I had made this clear in my lectures, but I will check and record more if not.
I hope that makes sense 🙂
Okay, from this I understood that if the project were to be financed entirely from equity, then the beta does not need re-gearing.
Actually, I had solved a few questions in which I had to re-gear the beta, and they were in F9 syllabus, that’s why I was a little confused. But this does make sense. I appreciate your time. Thanks a lot.
Regards.I have faced the same problem, after watching lecture videos, i went solving Dec-10 CJ CO. I didnt regear it, but when i looked at ans it was regeared. I searched for the problem on the internet and i m glad i found this thread. Thank you Sir JOHN, u have made our life so easier.
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