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how to calculate the cost of equity if one of the company is only financed by equity?(100% equity)
example :
Textile company have gearing ration of 150% want to invest in Software company
software company have 1.2 beta and 100% equity financed
You have not made it clear what you are asking. I assume you are wanting to know what the project specific cost of equity is (which is what is asked in the exam in relation to this sort of thing).
Since the software company is 100% equity, the asset beta will equal the equity beta of 1.2. (The only reason ever for the equity beta to be different than the asset beta is because of gearing).
To work out the cost of equity that the textile company will therefore apply, you need to use the asset beta formula to calculate the relevant equity beta – using the asset beta from the software company of 1.2, and the gearing of the textile company.
(The gearing ratio of 150% must be debt/equity, but appreciate that gearing can be measured in two ways although the examiner always makes it clear which way he is using in the question).
I really do suggest that you watch my free lectures on all of this – I explain in detail with examples.
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