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Forums › ACCA Forums › ACCA AFM Advanced Financial Management Forums › How Ke is calculated
I was going through BPP exam kit Q 71.
They calculated Cost of Equity (Ke) as below;
Ziwa’s Co MV of debt 1785 M$ and MV of equity 1400M$.
Ziawa’s cost of capital is 9.4% and geared cost of equity is 16.83%. Pretax cost of debt is 4.76%. Tax rate 25%
The cost of equity is calculated as;
16.83%=Ke+.75(Ke-4.76%) x 1785/1400
Ke=10.93%
I am not understanding how this formula is derived or why they calculate in this way.
Kindly help.
Thanks.
You are not expected to be able to derive the formula – it is M&M Proposition 2. The first formula on the formula sheet.
Using the formula is explained in Chapter 12 of our free lecture notes, and the free lectures that go with it.