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Dear sir
In question Tisa Co, part a, “It can be assumed that 80% of Elfu Co’s debt finance and 75% of Elfu Co’s equity finance can be attributed to other activities excluding the component production.” In the solution:
1.217 = component asset beta x 0.25 + 1.078 x 0.75, why use 75%?
I read your reply earlier
“Because it is equity that carries the risk so we used the 75% to calculate beta”
” if two streams with different betas are combined together then the overall beta is the weighted average of the two individual betas.”Could you please help to check if my below understandings are correct?
Question 1:
Here question give 75% equity and 80% debt only, so we have to use 75% equity ;
If the question have given a eg. 75% equity, 80% debt, AND 60% ASSET, we should use 60% instead of 75% for ßa calculation right?Question 2:
So far i have not yet encounter weighted average method for ße, so using Tisa as an example
(although not asked by question)
ße of component production = (1.4-1.25*0.75)/0.25=1.85Thank you!
We use 75% here because the question specifically says that 75% of the equity finance can be attributed to other activities (and therefore 25% is attributed to component production).
We need to know what % of Tisa is in each of the two fields and so if the question had said instead that 60% of the business was in other activities then we would use 60% and 40% (but it could not have written both 75% and 60% because that would not make sense).We could use the weighted average method on the equity betas only if the gearing in the two companies was in the same. It isn’t the same and therefore as I explain in my lectures, we need to calculate the asset beta and then gear it up by Tisa’s gearing to get the equity beta.
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