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In which calculation for the CAPM requirements you would use the asset beta or the equity beta respectively. My thinking is that CAPM is calculating cost of equity which is equity finance only and should use the beta asset. Kindly explain the rationale for using beta asset or beta equity in the CAPM formula.
The equity beta measures the risk of the share, and it is always the equity beta that is used in the formula to calculate the cost of equity (however the company is financed).
The asset beta measures the risk of the business itself (ignoring the effect that gearing has on the risk to the shareholders). It is relevant when considering changes in the level of gearing – the asset beta will be unchanged, but the equity beta will change with different levels of gearing and can be calculated using the asset beta formula on the formula sheet.
(The only situation in which the equity beta is equal to the asset beta is when the company is entirely equity financed, which is rather unlikely to be the case in the exam.)
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