Hello Mr.John, Considering above question and answer, normally debt to equity (debt/equity) mean its d=0.4 ,e=1, And i understood this,

But here gearing is 0.4 where it can be debt/equity or debt/(debt finance+equity ) , to make sure this there is extra details (debt : equity)

when it states debt : equity (again its not debt /equity ) the total capital is = 1 , not equity = 1, (if i call back P5 APM鈥檚 EVA calculation) so here ve=0.6 , vd=0.4 ? OR am i missing something here please explain

Hi Sir, Mostly what we do is when debt:equity = 0.4 we assume debt is 0.4 and equity is 0.6 hence debt = 40 equity = 60 total Ve plus Vd = 100 is this wrong?

Hi ark11! Remember that gearing is the proportion of debt finance to equity finance. How much of debt do we have compared to equity? That means we assume equity is 1 and debt is the proportion of that (i.e. 0.4).

Here, the debt is technically 40% of equity so we can assume that equity is 100 and debt is 40 of that, so total finance is 140. Calculate it in reverse to check: 40/100 = 0.4. If you used 40 and 60 in a debt:equity ratio, then you’ll have 40/60 = 0.67, which is incorrect.

Hello Mr.John, Considering above question and answer, normally debt to equity (debt/equity) mean its d=0.4 ,e=1, And i understood this,

But here gearing is 0.4 where it can be debt/equity or debt/(debt finance+equity ) , to make sure this there is extra details (debt : equity)

when it states debt : equity (again its not debt /equity ) the total capital is = 1 , not equity = 1, (if i call back P5 APM’s EVA calculation) so here shouldn’t be ve=0.6 , vd=0.4 ? OR am i missing something here please explain

Hello Hamjath, If I’m understanding you correctly, it seems the part you are mistaken is that “total capital = 1”. It’s not.

Using (Debt:Equity) – Debt’s proportion to equity is 0.4. That means for every 1 equity finance, debt is 0.4 of that. Thus, total finance here will be 0.4 + 1 = 1.4.

At the end of this chapter, I will be halfway through the AFM syllabus and I should be happy but being done with AFM also means this will be my last exam taught by you, Mr Moffat so I am also very sad. You are indeed the best teacher I’ve ever had. I owe my pass in F5 and F9 to you. I also changed my mind and chose AFM instead of ATX because I enjoyed learning it so much! Thank you for all your effort!

I had a question : If we鈥檙e to use the CAPM model to find out the Beta, as suggested in your lecture , but I don鈥檛 know what number to use for return from the market as it鈥檚 not given in the question. Thank you

For example 1 in the lecture notes (which is the example that this lecture is working through), the beta is not needed because the MM formula (given on the formula sheet) does not require the beta, provided we know the ungeared cost of equity (which we do know, because it is given in the question).

What I do refer to is the fact that you could get the same answer by calculating the beta and then using the asset beta formula. This takes longer and so it is better an quicker to use the formula, but if you want to try it then use any market return you want and you will find that you end up with exactly the same result. (When I say use any market return you want, obviously it must be higher than the risk free rate of 8%).

If you are good with numbers then have a go and you will see what I mean. But in the exam, it is again faster and more efficient to use the formula that is provided on the formula sheet.

This is what i did… I took/assumed return to market as 9% As we know the ungeared cost of equity (in the question). We can find out the beta. 15%(Ke ungeared) = 8% + beta (9%-8%) ungeared equity beta = 7 equity beta is equal to asset beta as it was ungeared Be=Ba = 7 using Ba formula – to find out what the Be ungeared beta we know to be as 7. What we want is geared equity Beta to later calculate the geared cost of equity. 7=1/1+0.4(1-0.3)*Be 7=0.78125*Be 7/0.78125=Be Be=8.96 Now i applied the new Be to the CAPM formula Ke = 8% + 8.96(9%-8%) =16.96 Then we can use WACC…and get the same answer!

In the below example by @stevegeorge seems to be formula mistake. I think he forgot brackets and 6th line from the bottom should be 7=1/(1+0.4(1-0.3))*Be otherwise result is 7=1.28Be

But most importantly I wanted to ask for assumption of return to market as 9%. Can I just assume any value? I see that it will not change the formula results.

Hello John, I’ve watched most of your lectures on open-tuition on P4/AFM and have absolutely enjoyed all of them! You make financial management seem logical and easy in the most effortless manner. Concepts which used to be abstract to me are absolutely clear, and all the credit goes to you. I wanted to thank you for all of your wonderful inputs. Words can’t express my gratitude.

759181024@qq.com says

Modigliani & Miller is accronymed M&M, how cute is that

hamjath says

Hello Mr.John,

Considering above question and answer,

normally debt to equity (debt/equity) mean its d=0.4 ,e=1, And i understood this,

But here gearing is 0.4 where it can be debt/equity or debt/(debt finance+equity ) , to make sure this there is extra details (debt : equity)

when it states debt : equity (again its not debt /equity ) the total capital is = 1 , not equity = 1, (if i call back P5 APM鈥檚 EVA calculation)

so here ve=0.6 , vd=0.4 ? OR am i missing something here please explain

Regards

mohamed hamjath

John Moffat says

Writing debt:equity is a standard way of writing the ratio of debt to equity (i.e. debt / equity)

hamjath says

thanks

John Moffat says

You are welcome 馃檪

ark11 says

Hi Sir,

Mostly what we do is when debt:equity = 0.4

we assume debt is 0.4 and equity is 0.6

hence debt = 40

equity = 60

total Ve plus Vd = 100

is this wrong?

ashlan says

Hi ark11!

Remember that gearing is the proportion of debt finance to equity finance. How much of debt do we have compared to equity? That means we assume equity is 1 and debt is the proportion of that (i.e. 0.4).

Here, the debt is technically 40% of equity so we can assume that equity is 100 and debt is 40 of that, so total finance is 140.

Calculate it in reverse to check: 40/100 = 0.4.

If you used 40 and 60 in a debt:equity ratio, then you’ll have 40/60 = 0.67, which is incorrect.

Hope this helps!

hamjath says

Hello Mr.John,

Considering above question and answer,

normally debt to equity (debt/equity) mean its d=0.4 ,e=1, And i understood this,

But here gearing is 0.4 where it can be debt/equity or debt/(debt finance+equity ) , to make sure this there is extra details (debt : equity)

when it states debt : equity (again its not debt /equity ) the total capital is = 1 , not equity = 1, (if i call back P5 APM’s EVA calculation)

so here shouldn’t be ve=0.6 , vd=0.4 ? OR am i missing something here please explain

Regards

mohamed hamjath

hamjath says

it has to be Ve=0.6 , Vd=0.4, isn’t it

ashlan says

Hello Hamjath,

If I’m understanding you correctly, it seems the part you are mistaken is that “total capital = 1”. It’s not.

Using (Debt:Equity) – Debt’s proportion to equity is 0.4. That means for every 1 equity finance, debt is 0.4 of that. Thus, total finance here will be 0.4 + 1 = 1.4.

sciency96 says

At the end of this chapter, I will be halfway through the AFM syllabus and I should be happy but being done with AFM also means this will be my last exam taught by you, Mr Moffat so I am also very sad. You are indeed the best teacher I’ve ever had. I owe my pass in F5 and F9 to you. I also changed my mind and chose AFM instead of ATX because I enjoyed learning it so much! Thank you for all your effort!

John Moffat says

Thank you very much for your comment 馃檪

annakd says

Hi Sir,

Thank you for your lectures.

I had a question :

If we鈥檙e to use the CAPM model to find out the Beta, as suggested in your lecture , but I don鈥檛 know what number to use for return from the market as it鈥檚 not given in the question.

Thank you

John Moffat says

For example 1 in the lecture notes (which is the example that this lecture is working through), the beta is not needed because the MM formula (given on the formula sheet) does not require the beta, provided we know the ungeared cost of equity (which we do know, because it is given in the question).

What I do refer to is the fact that you could get the same answer by calculating the beta and then using the asset beta formula. This takes longer and so it is better an quicker to use the formula, but if you want to try it then use any market return you want and you will find that you end up with exactly the same result. (When I say use any market return you want, obviously it must be higher than the risk free rate of 8%).

If you are good with numbers then have a go and you will see what I mean. But in the exam, it is again faster and more efficient to use the formula that is provided on the formula sheet.

stevegeorge says

This is what i did…

I took/assumed return to market as 9%

As we know the ungeared cost of equity (in the question). We can find out the beta.

15%(Ke ungeared) = 8% + beta (9%-8%)

ungeared equity beta = 7

equity beta is equal to asset beta as it was ungeared

Be=Ba = 7

using Ba formula – to find out what the Be

ungeared beta we know to be as 7. What we want is geared equity Beta to later calculate the geared cost of equity.

7=1/1+0.4(1-0.3)*Be

7=0.78125*Be

7/0.78125=Be Be=8.96

Now i applied the new Be to the CAPM formula

Ke = 8% + 8.96(9%-8%) =16.96

Then we can use WACC…and get the same answer!

John Moffat says

Yes – exactly 馃檪

konrad79 says

In the below example by @stevegeorge seems to be formula mistake. I think he forgot brackets and 6th line from the bottom should be 7=1/(1+0.4(1-0.3))*Be otherwise result is 7=1.28Be

But most importantly I wanted to ask for assumption of return to market as 9%. Can I just assume any value? I see that it will not change the formula results.

thanks

sahana20 says

Hello John, I’ve watched most of your lectures on open-tuition on P4/AFM and have absolutely enjoyed all of them! You make financial management seem logical and easy in the most effortless manner. Concepts which used to be abstract to me are absolutely clear, and all the credit goes to you. I wanted to thank you for all of your wonderful inputs. Words can’t express my gratitude.

John Moffat says

Thank you very much indeed for your comment 馃檪