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Asset and equity beta

Forums › Ask ACCA Tutor Forums › Ask the Tutor ACCA AFM Exams › Asset and equity beta

  • This topic has 6 replies, 5 voices, and was last updated 6 years ago by John Moffat.
Viewing 7 posts - 1 through 7 (of 7 total)
  • Author
    Posts
  • November 23, 2012 at 11:49 pm #55684
    Anonymous
    Inactive
    • Topics: 1
    • Replies: 0
    • ☆

    Dear tutor / fellow students

    When do I use asset beta to calculate cost of capital and when do I use equity beta? I am a little confused as to when I need to ungear and when I do not need to. Is there a rule of thumb that I should follow? Or are there any examples to illustrate?

    November 24, 2012 at 12:53 am #108546
    dazhong0703
    Member
    • Topics: 44
    • Replies: 130
    • ☆☆

    https://opentuition.com/groups/ask-the-tutor-acca-p4-exams/forum/topic/apv-and-ke/

    November 24, 2012 at 1:11 am #108547
    dazhong0703
    Member
    • Topics: 44
    • Replies: 130
    • ☆☆

    Equity beta represents the systematic business risk and financial risk of a company, and asset beta reflects only the business risk of a company. If a company is all equity financed, the equity beta is exactly equal to asset beta. 
    As long as a company operates in its existing business, its asset beta remains constant. However, the equity beta will change as company’s gearing (financial risk) change, the higher gearing ratio, the higher equity beta. 

    Step1: calculate the beta asset (business risk) of company by degearing the beta equity. 
    In this step, the beta asset is unknown variable, and Debt and Equity is used the market value before the gearing changed. 
    If you are not given beta debt, we normally assume beta debt is zero 

    Step 2: calculate the new beta equity by regearing the new debt / equity ratio, the formulae is same but the beta equity is unknown variable 
    The Debt and Equity is used the new gearing ratio after company adjusting its capital structure. 

    Step 3: calculating the cost of equity (Ke) by using CAPM model 

    Step 4: Estimate cost of debt (Kd) at new gearing ratio. We should note that the cost of debt may rise if gearing ratio increase, as company’s credit rating may fall under a higher gearing ratio and debtholders require higher return. 

    Step 5: Calculating the WACC under a new gearing ratio. 

    November 25, 2012 at 8:42 am #108548
    John Moffat
    Keymaster
    • Topics: 57
    • Replies: 54675
    • ☆☆☆☆☆

    Excellently explained 🙂

    June 7, 2018 at 10:42 pm #457666
    dipatil
    Participant
    • Topics: 56
    • Replies: 104
    • ☆☆

    Very clearly explained 🙂

    June 8, 2018 at 12:31 am #457675
    mjibola
    Participant
    • Topics: 131
    • Replies: 135
    • ☆☆☆

    I understand this part, but can someone point out where we use M and M with tax formula?

    Normally I use the asset beta formula for ungearig and regearing. But I don’t know where and when it’s appropriate to use the M and M with tax?

    June 8, 2018 at 8:50 am #457731
    John Moffat
    Keymaster
    • Topics: 57
    • Replies: 54675
    • ☆☆☆☆☆

    Firstly, the asset beta formula is actually M&M and so they both will give the same answer.

    The MM formula for getting the cost of equity of a geared company is not often relevant in the exam but is easier when you are not given the betas (because otherwise, you have to calculate the beta from the cost of equity and then use the asset beta formula, which takes longer).

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Viewing 7 posts - 1 through 7 (of 7 total)
  • The topic ‘Asset and equity beta’ is closed to new replies.

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