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I have two questions that are confusing me from a long time! Somebody, please help me with this!
1) If a similar company has Beta which is entirely ungeared Beta [meaning no debt], then do we have to calculate firstly ASSET Beta for our company or we can ungear Beta of the similar company directly to calculate EQUITY Beta for our company [meaning we don’t have to calculate Asset Beta since the similar company has no [debt] & there is no point to ungear it?
In other words, If Beta of similar company is ungeared, so can we directly use this to calculate EQUITY Beta without calculating Asset Beta because it is already ungeared?
2) If Beta of similar company is geared [meaning it has both debt & equity raised finance], then we have to ungear the geared BETA of similar company to use it for our geared company Beta calculation? [right?]
The only reason that the equity beta is different from the asset beta is because of gearing in the company – more gearing make the shares more risky and therefore the equity beta will be higher.
If there is no gearing then the equity beta is equal to the asset beta.To get the equity beta for our company, we find a company in the same business – the two companies will have the same asset beta. If the similar company is geared the we need to use the formula to calculate the asset beta from the equity beta, using the gearing of the similar company. If the similar company is not geared, then the asset beta is equal to the equity beta of the similar company.
When we know the asset beta of the similar company and therefore the asset beta of our company, then if our company is geared we need to use the formula to calculate the equity beta for our company (using the gearing of our company). If our company has no gearing, then the equity beta for our company will be equal to the asset beta that we found from the similar company.
All of this is explained (with examples) in my free lectures. The lectures are a complete free course for Paper FM and cover everything needed to be able to pass the exam well.
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