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Dear Sir,
question:
Leach Co is an all equity financed company which wishes to appraise a project in a new ares of business. Its existing equity beta is 1.2. The average equity beta for the new business area is 2.0, with an average debt/debt equity ratio of 25%. The risk free rate of return is 5% and the market risk premium is 4%.
Ignoring taxtation and using the capital asset pricing model, what is the risk – adjusted cost of equity for the new project?
How do I tackle this question?
Thanks.
You calculate the asset beta for the project (using the average equity beta for the new business area and the average debt/equity ratio).
Since Leech is all equity financed, the equity beta relevant for the project will be the same as the asset beta calculated.
You use the equity beta as normal to calculate a cost of equity for the project.Have you not watched my free lectures, because this is all explained in the lectures? The lectures are a complete free course for Paper F9 and cover everything needed to be able to pass the exam well. You should not be attempting questions in your revision kit until you have completed your studying.
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