ACCA FM · Guided practice (Show me how)
Chapter 21: CAPM and MM combined
Asset betas - ungear, regear and a project cost of equity
Debt is assumed risk-free (beta of debt zero), so the asset beta formula reduces to: asset beta = Ve / (Ve + Vd (1 - T)) x equity beta. Gearing ratios are debt to equity at market values.
(a) P plc has a gearing ratio (debt to equity) of 0.4 and the beta of its shares is 1.8. Q plc has a gearing ratio of 0.2 and the beta of its shares is 1.5. The rate of corporation tax is 30%.
(b) X plc is an oil company with a gearing ratio (debt to equity) of 0.4. Shares in X plc have a beta of 1.48. They are considering investing in a new operation to build ships, and have found a quoted shipbuilding company - Y plc. Y plc has a gearing ratio (debt to equity) of 0.2, and shares in Y plc have a beta of 1.8. The market return is 18% and the risk free rate is 8%. Corporation tax is 25%. Calculate the project specific cost of equity, rounding betas as the notes do (asset beta to 2 decimal places).
(a) Share risk and business risk
Identify the riskier share and calculate the companies' asset betas and relative business risk.
(b) X plc: project cost of equity
Calculate X plc's proxy asset beta, project equity beta and project-specific cost of equity.
Opening this exercise…