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Sir there is a question kit that
A company is going to take on a project using mix of equity and debt finance in an economy where tax rate is 30%
Assuming perfect markets, other than tax, which of the follwing statements is true about project
a)Beta equity greater than beta asset, WACC less than Ke calculated using beta asset , WACC less than Ke calculated using beta equity
b)Beta equity less than beta asset, WACC greater than Ke calculated using beta asset , WACC greater than Ke calculated using beta equity
c)Beta equity greater than beta asset, WACC less than Ke calculated using beta asset , WACC greater than Ke calculated using beta equity
d)Beta equity less than beta asset, WACC greater than Ke calculated using beta asset , WACC less than Ke calculated using beta equity
Correct ans is A, but please can you explain. This I know that in geared company beta equity is greater than beta asset…
If you watch my lectures on M&M, you will see that the WACC falls with higher gearing.
Therefore the WACC of a geared company will be less than the WACC if it was entirely equity finance (which would be the cost of equity calculated using the asset beta).You will also see that the WACC for any level of gearing is the weighted average of the cost of equity and the cost of debt, so the WACC of a geared company must be lower than the cost of equity (calculated using the equity beta).
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