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Hi,
There are several exercises where the asset beta of a similar company is being calculated and then used in the CAPM formula directly (an not being geared).Also the Ke found is then used for discounting without calculating WACC.
In these exercises it is stated that the projects will be fully funded out of debt – is this the reason of all the above? If yes will you be able to explain the logic?
Many Thanks
Hi mari,
Yes, the ungeared cost of equity is used, because the projects are fully funded out of debt.If the projects are 100% debt financed, the tax saved from the use of debt would be significant. Therefore, we’re expected to estimate the impact of such a benefit on the project.
Before doing that, we need to separate the impact of debt financing and calculate the NPV of the project as if it is all-equity financed(so called base-case NPV). Therefore, asset beta is used to drive ungeared cost of equity, and this is used as discount rate.
Thanks,
Indeed – I was going more deep in the Text Study book and got the same understanding.
Mari15 – Please do not ask the same question in two different forums!!
It is because Burung asks for the APV, and Fubuki involves a significant change in gearing in which case, again, it requires an APV approach.
I do suggest that you watch my free lectures on this – APV is very often examined.
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