Sir,
Can you please explain this OpenTuition Mock test question?
AJT Co has gearing ratio (D/E+D) of 30%. Corporation tax is 25%. Asset beta is 1.2
Risk free return is 5% and Market return is 12%
What is the cost of equity?
Many thanks.
Ask the Tutor ACCA FM
Cost of Equity
You are given an Asset beta. You need to covert it to the share beta as follows.
Asset beta = Ve/Ve+Vd(1-T) *Equity beta
1.2 = 100/(100+30*0.7)*Ke
Be = 1.47
Ke = ro + Be (rm-ro)
= 5%+1.47(12%-5%)
=15.29%
11y ago#2Moses answer is NOT correct for two reasons. He has the gearing wrong, and also has the tax rate wrong.
Since the gearing is given as debt:debt + equity. It means that if equity + debt is 100, then debt is 30 and therefore equity is 70.
So....using the asset beta formula,
1.2 = (70 / (70 + 30*0.75))*Be
So Be = 1.586
So cost of equity = 5% + 1.586(12%-5%) = 16.10%
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