- This topic has 1 reply, 2 voices, and was last updated 12 years ago by
.
- Posts
It is said that when debt is introduced it will result in increased cost of equity as the equity holder will be in danger, because there will be left low profit for them after deducting the fix interest expenses.
My question is that how we incorporate or calculate this effect of increase in cost of equity, I know how to corporate it into WACC, but I want to know for my knowledge that how this effect is calculated?
Regards,
Tasawwur WaraichHi,
When gearing increases the cost of equity increases you are correct.
But how r u incorporate this?1. We need beta, to find cost of equity.
2. We need to know whether business risk is changed or remain same?
3.if business risk is changed then ungear the proxy’s beta or similar industry sector
And regear with your new financial /gearing ratio. With this geared beta you can find cost of equity.
4. If a new business changes only financial risk ( business risk remain same) then remember to use APV method. Used only ungeared beta.( 3rd step) to find cost pf equity.Hope this will help.
Nandini
- You must be logged in to reply to this topic.