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Hello sir.
Just Have finished practicing Sept 2016 exam question 32) part b)
So my question is : In Capital Asset Pricing model we look into systematic risk. Connecting this to Investing appraisal, the formula for Beta Equity (Ke=Rf + b(Rm-Rf)). so its the Required rate of return required by investors. Tell me please if its Ke from the formula is Cost of Equity how can we appraise projects if only ever WACC is used ( according to my knowledge). Please confirm.
2)If the Gearing is 0. Asset beta=Equity beta and equals 1? because there will be no other risks except the ones set by the market and the risk of the Business will be the same as Market riskiness. am i right? please check.
We appraise investments using the WACC.
The WACC is the weighted average of the cost of equity and the cost of debt.
The cost of equity is the same as the shareholders required rate of return and is calculated by either using CAPM (on the equity beta) or using the dividend valuation formula backwards, depending on what information is given in the question.If there is no gearing, then yes – the equity beta will equal the asset beta.
This is because there is no gearing risk.
The only risk measured by the beta is the systematic (market) risk, measured relative to the market as a whole. There will of course also be unsystematic (company specific) risk, but we assume always that shareholders are well-diversified and that therefore this is not relevant to determining the shareholders required rate of return.
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