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Hi
Can you please explain the below questionLeah co is an all equity financed company which wishes to appraise a project in a new area of business. Its existing beta is 1.2. The average equity beta for a new business area is 2.0, with an average debt/equity plus equity ratio of 25%. The risk free rate is 5% and market premium is 4%.
Ignoring tax what is the risk adj cost of equity of new project?
You need to calculate the asset beta using the average debt/equity ratio.
This gives the asset beta for the new project.
Since Leah is all equity financed, the equity beta for the new project will be the same as the asset beta.You then use this beta in the normal CAPM formula to calculate the project specific (i.e. risk adjusted) cost of equity.
I explain how to calculate the project specific cost of equity (and explain the logic) in my free lectures on CAPM.
The lectures are a complete free course for Paper F9 and cover everything needed to be able to pass the exam well.
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