In Q4/5, could you kindly explain the reason that you used CAPM formula to calculate the cost of debt? I do not understand it. Thanks for your help always.

The question gave the beta of debt. The beta of anything measures its risk. Usually we assume that the beta of debt is zero and therefore risk free. However in real life debt is never completely risk free. Just as the beta of equity determines the cost of equity, similarly the beta of debt determines the cost of debt (before tax).

Just wanted to say that the way you explain things is just amazing. And i was confused about q4 of chap 20 but after reading ur comment it got cleared. I have a small question though, the E(r) can also be referred as required rate of return???

Please can you explain why in ch20 practise question 2 of 5 we don’t deduct the risk free from the equity premium but we do deduct it from market return in question 1 of 5 of the test?

If you have watched the free lectures, then you will remember that the risk premium is the difference between the market return and the risk free rate. If, for example, the market return is 10% and the risk free rate is 3%, then the risk premium is 7%. In the exam, sometimes you are given the market return (in which case you need to subtract the risk free rate) and other times you are given the risk premium (in which case you don’t subtract the risk free rate because it has already been subtracted). Make sure you read the question carefully in the exam.

YK2017 says

Thank you very much!

eceesay says

100%

Thanks John, i really am grateful.

sushanth12 says

80percent

hlony says

Hi John,where did we get the 10% we multiplied the 70% of equity with?

John Moffat says

In future, please say which question you are referring to.

We got 10% by using the CAPM formula on the formula sheet. It is risk free + (beta x market premium) which is 4% + (1.2 x 5%).

Teslim says

Hi John,

In Q4/5, could you kindly explain the reason that you used CAPM formula to calculate the cost of debt? I do not understand it. Thanks for your help always.

John Moffat says

The question gave the beta of debt. The beta of anything measures its risk. Usually we assume that the beta of debt is zero and therefore risk free. However in real life debt is never completely risk free.

Just as the beta of equity determines the cost of equity, similarly the beta of debt determines the cost of debt (before tax).

Teslim says

Thank you sir.

John Moffat says

You are welcome 🙂

sheen says

Hi Mr. John,

Just wanted to say that the way you explain things is just amazing. And i was confused about q4 of chap 20 but after reading ur comment it got cleared.

I have a small question though, the E(r) can also be referred as required rate of return???

John Moffat says

Thank you for the comment, and what you say about E(r) is correct.

artid1 says

Hi

Please can you explain why in ch20 practise question 2 of 5 we don’t deduct the risk free from the equity premium but we do deduct it from market return in question 1 of 5 of the test?

Look forward to your reply

Thank you

John Moffat says

If you have watched the free lectures, then you will remember that the risk premium is the difference between the market return and the risk free rate.

If, for example, the market return is 10% and the risk free rate is 3%, then the risk premium is 7%.

In the exam, sometimes you are given the market return (in which case you need to subtract the risk free rate) and other times you are given the risk premium (in which case you don’t subtract the risk free rate because it has already been subtracted).

Make sure you read the question carefully in the exam.

artid1 says

Hi John

okay that makes sense

thank you!!

John Moffat says

You are welcome 🙂