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If a geared company’s asset beta is used in the CAPM formula (ri = rf + ßi (rm – rf)) what
will ri represent?A The WACC of the company
B The ungeared cost of equity
C The geared cost of equity
D The market premium
Answer is B -CAPM can be used to predict the cost of equity. Using an asset beta will predict the
ungeared cost of equity. Using the equity beta (geared beta) will predict the geared cost of
equityI dont get it?
The asset beta measure the risk of the shares if there is no gearing.
With gearing, share are more risky and therefore the beta will be higher. The equity beta measures the risk of the shares with gearing.
I suggest that you watch my free lectures on CAPM where this is all explained.
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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