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which one we use as weighting to find average asset beta?
1)equity value/ total combined equity value
2) (equity+debt)/ (total combined equity +debt)
do we have to include debt in the weighting?
I think its weighted according to the mkt capitalization of each company/total mkt capitalization of both companies*Beta of the respective co.
Idk,lets wait for the instructors reply
jesschin90:
Because it is equity that is carrying the risk, you should weight by the equity values.
Dear Tutor,
Thanks for your answer but i need further clarification.
I have seen 2 worked examples (BPP – my study text) on the weighted average beta issue
CASE 1
Only book value of equity and debt was available for both companiesSolution
Total Value of A (i.e book values of Debt & Equity)/Total Values of A&B (debt &equity – book values) + Total Value of B (book values of Debt & Equity)/Total Values of A&B (debt &equity) multiplied by their respective betas.CASE 2
Given ( book value of debt and Mkt Value of equity)Solution
ONLY the Mkt values of equity of both companies was used for the weightings (please note that the question was silent on how to weight the average beta)I understand you have asked us to use Equity values as the weightings in your response above. Does this apply even when we are given Mkt Values of both Equity and Debt (for both companies) in the exam , we should still use ONLY equity for the average beta weighting?
In addition if we had CASE 1 above in the exam, what will be your advise on the weighting to use.
Lastly when we get the average beta and we need to gear it to get Equity Beta of the combined company. what is the correct weightings to use under the following circumstances below…..supposing we are not given the gearing ratio of the combined company like in Dec 2013, Q 3?
A. The acquisition will be financed by debt only
B The acquisition will be share for share exchange
C The acquisition will be all cashSorry i know i have asked a lot (need to pass this time)
Many thanks in advance
I cannot really comment on BPP because I do not have their books (so I cannot tell if there were any special reasons).
However, strictly you should weight by the values of the equity (as in Dec 2013 Q3, even though both companies were of course geared – otherwise their asset betas would have been equal to their equity betas).With regard to your second question, it really depends on what you are being asked to do, and (where relevant what assumptions to state (as always!). In Q3, given the question and the information there was no choice but to discount the flows at the cost of equity that had been calculated and to use the gearing given.
What you would be looking to try and do in your A,B,and C would be identify the new gearing ratio – in B and C there would be no additional debt, so you would probably (without extra information) have no choice but to use the existing gearing ratio. Obviously in A there would be a change of gearing – again, depending on whether or not you had additional information you would probably use existing total equity and new total debt to get the ratio.
However, as always, make it clear what you are doing and provided it is sensible (and what I have written above is) then you would get most if not all of the marks.hello Sir,
There is one one more example, Past paper Jun 11, wherein total firm value has been used instead of equity value in calculating average asset beta. Any specific reason for that ?
No – the examiner has not been consistent on this, which is annoying.
Using equity makes sense (because it is equity that carries the risk) and that is what the examiner has done more recently, but certainly in earlier questions he had used the total firm value.
Given that he is not consistent, then he will without doubt give full marks for using either as the weighting. Just make sure (as for all P4 questions) that you state your assumption, and then you will still get the marks.
No – the examiner has not been consistent on this, which is annoying.
Using equity makes sense (because it is equity that carries the risk) and that is what the examiner has done more recently, but certainly in earlier questions he had used the total firm value.
Given that he is not consistent, then he will without doubt give full marks for using either as the weighting. Just make sure (as for all P4 questions) that you state your assumption, and then you will still get the marks.
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