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Good day to you
Please kindly assist me on the above mentioned question: a studymate of mine and I worked out the gearing on the new structure, but the solution worked it out on the old structure. What is the reason behind using the old one, when the company structure has changed?
You will have to say which part of the answer you are referring to.
The question asks for the WACC before and after implementing the proposal, so the answer has used the current structure for ‘before’ and the new structure for ‘after’/
Yes the question asked for the WACC before and after the proposal. Now, in answering the question, we used the new capital employed in calculating the new asset beta, but in the solution, the old capital structure was used (that being the 50/50), which brings back my original question of why.
They use the existing gearing to calculate the asset beta because they are calculating it from the existing equity beta (which is based on the current gearing).
They then use the fact that the total beta is the weighted average of the individual betas in order to calculate the asset beta of hotel services (as explained in my free lectures on CAPM).
They then use the new gearing to calculate the new equity beta, and to calculate the new WACC.
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