The capital asset pricing model (part 2) – ACCA (AFM) lectures
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I think you have them switched, it should be 50/87.5 hence Be is 0.8943
No – don’t forget that the equity beta will always be higher than the asset beta
Example 6 felt like Inception…..
X is not investing in company Y at all. However the gearing used to appraise the new project is the gearing used in the project, not the current gearing of the company.
The asset beta is measuring the risk due to the type of business i.e. ignoring any gearing. So the asset beta of the new project will be the same as the asset beta of Y because they are both involved in shipbuilding.
Hello
I understand that we are ungearing the capial structure of company Y to understand risk factor of investing by purely acquiring shares in Y. But in part b we are not changing the captital structure of company Y are we? Company X is just investing by acquiring 50% shares and 50% debt in company Y. This does not modify the capital structure of company Y to 50 50, does it? Tha should depend on how much Comp X is investing in Comp y in proportion to COmpany Ys current capital structure.
Could you please clarify why we are using the Asset beta of comnpany Y with a structure of 20:100 and apply the same asset beta for a modified structure of 50:50 to calculate equity beta?
I have been replaying this part too for like 5x now and I am entirely confused as the Beta of 1.565 was ungeared as it has the D/E ratio of 0.2. I am not sure the calculations for b was correct either. Cos we have simply changed the gearing ratio.
I think I have it figured out now. the Beta of 1.565 is the ungeared beta of Y. While 1.8 given in the question is the geared Beta. Now using the ungeared beta of Y which is a similar company to the shipbuilding company and hence that assumes the Shipbuilding industry has an Asset Beta of 1.565, we can then calculate the Equity beta of this new company using the D/E ratio of 50/50. This equity beta will be specific to the new company.