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Sir, there’s a section B question on BPP which highlights exactly my question. The cost of equity calculated was based on current equity beta of 1.05. My question is : They plan to issue loan notes for the expansion hence wouldn’t that increase the market value of debt which according to the formula, change the equity beta?
As I have answered to you several times (and as I explain in my lectures) the new debt raised is only relevant for the calculation of the cost of equity if the question specifically asks for a project specific cost of equity. This question does not ask for a project specific cost of equity – it tells you the equity beta and simply asks for the cost of equity.
Obviously raising more debt will increase the market value of debt. This might well cause the cost of equity to increase (although whether the change is at all significant depends on the current market values of equity and debt (and given it is a large company, 20M might well be a very small change)). However the question does not ask about this – it simply asks ‘what is the cost of equity’. It does not ask what will happen to the cost of equity.
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Thank you Sir, I think I understand now! Sorry for taking so long to get it!
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