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A bit confused on where/when we need to do the above. When carrying out a project peculiar to another industry, we ungear their equity beta, regear and calculate Ke. I get that.
But when do we have to find a combined asset beta before re-gearing? Do we do this strictly during a merger, acquisition/valuation?
We do it whenever two streams are combined that have different levels of risk.
This may be because one company is taking over another company (with a different level of risk), or it may be when one company is investing in a new major project that has a different level of risk.
Do watch my free lectures on CAPM where I explain this.
Thanks. I have.
But in example 6b for instance (in the lecture), why would it be wrong to also ungear X’s equity beta as well, weight this together with Y’s asset beta to get a combined asset beta (since X is investing in a new major project with a different level of risk) then regear this using X’s capital structure to arrive at Ke?
If we were asked to calculate the new WACC for X, then what you suggest would be correct.
However, what is asked is what discount rate to use for the new project. For this all that matters is the riskiness of the new project (together, for part (b), with the gearing in the new project). The riskiness of X before taking on the new project is of no relevance when deciding what return is needed for the new project
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