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Geared cost of equity

Forums › Ask ACCA Tutor Forums › Ask the Tutor ACCA FM Exams › Geared cost of equity

  • This topic has 1 reply, 2 voices, and was last updated 8 months ago by LMR1006.
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  • Author
    Posts
  • October 19, 2024 at 8:06 pm #712564
    Anonymous
    Inactive
    • Topics: 10
    • Replies: 6
    • ☆

    Hi. These two questions have the same requirement but have two different workings. I understand the first working, but I’m confused as to why the used a completely different working in the second question for the same requirement. This is from the Study Hub.

    1. Colt Co has an equity beta factor of 1.15 and an asset beta factor of 0.85. The risk-free rate of return is 8.5% and the market return is estimated at 12.4%. The corporate tax rate is 25%.

    What is Colt’s geared cost of equity?

    WORKING

    The cost of equity geared is using the equity beta in CAPM (i.e. 8.5% + 1.15(12.4% – 8.5%) = 12.985%)

    2. A company’s equity beta is 1.10 and its asset beta is 0.85. The market premium is 4.50% and the risk-free rate 3%

    What is the company’s geared cost of equity?

    A.4.3%
    B.4.65%
    C.6.8%
    D.7.95%

    WORKING

    Using CAPM, the cost of equity geared = Risk-free rate + (market premium × equity beta) = 3% + (4.50 × 1.10) = 7.95%

    October 20, 2024 at 12:31 am #712567
    LMR1006
    Keymaster
    • Topics: 4
    • Replies: 1511
    • ☆☆☆☆☆

    The first one asks
    The cost of equity geared , this
    8.5% + 1.15(12.4% – 8.5%) = 12.985%

    Ok so you are happy RF = 8.5% RM = 12.4% and Be = 1.15

    But the second one
    Has premium which is RM-RF already calculated as 4.5%
    3% + (4.50) × 1.10 = 7.95%

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