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John Moffat.
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humai
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Sir suppose A co is acquiring T co. Currently, A co has kd of 6%, and Ke of 4%. And examiner says that capital structure of the combined co will be same as current capital structure of A co, then we know that kd of combined co will also be 6% ( same as A co current kd). But what about Ke ? will it be 4% or will it be changed?
John Moffat
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Firstly, Ke would not be lower than Kd. Ke will always have been higher than Kd because equity is more risky than debt.
However if T Co has the same level of business risk as A Co then Ke would stay unchanged. Much more likely in the exam is the situation where T Co has a different level of business risk, in which case we need to ungear the betas and find the asset beta of the combined company, and then regear it in order to get the new cost of equity.
humai
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