CAPM / Asset beta question

Hi Tutor,

I am new to AFM. When going through the Kaplan exam kit ver.Dec-2021/Jun-2022 Q15 Westparley Co (Mar 20), I am stuck in this question.

Basically, Westparley Co is going to acquire Matravers Co and the question here is to calculate the weighted average cost of capital for the combined company. The market value of Matraver’s debt (Vd) is stated as “long-term loan currently trading at its book value of $6500m”.

Looking at the answer provided, (1) the asset beta calculation seems to have ignored the market value of the debt of both companies (i.e. the ‘Vd(1-T)’); (2) the combined company cost of equity has ignored Matraver’s market value of debt at $6,500m.

Is this correct, or the writer may have made an error? I have searched online and run through both the study text and opentuition notes but was unable to find a reasonable explanation why it should be left out in such a way.

Please kindly advice why it should be left out. If it is an error, what should be the correct ‘combined company cost of capital’?
Many thanks!

An extract of the answer as follow (please refer *here*)

“Appendix 2: Estimate of combined company cost of capital

Matravers Co asset beta = 0.75

Westparley Co asset beta
Market value of debt = 1.05 x 26,000m = $27,300m
Market value of equity = 4,000m x $8.50 = $34,000m
Asset beta = 1.02 x (34,000)/(34,000 + (27,300 x 0.72)) = 0.65

Combined company, asset beta
(**here**) Asset beta = ((0.75 x 12,500) + (0.65 x 34,000)) / (12,500 + 34,000)) = 0.68
Equity beta = 0.68 ((34,000 + (27,300 x 0.72)) / 34,000) = 1.07

Combined company cost of equity = 3.5% + (1.07 x 8%) = 12.1%
(**here**) Combined company cost of capital =
((34,000 x 12.1%) + (27,300 x 9.8% x 0.72)) / (34,000 + 27,300) = 9.9%, say 10%”