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Ques –
TR Co has a gearing level of 1:3 debt:equity. TR is considering diversifying into a new market without changing its
existing gearing. B Co is already operating in the new market. B Co has an equity beta of 1.05 and a gearing level of
1:4 debt:equity. Both companies pay 30% corporation tax.
a) What is the asset beta relevant to TR for the new market (to 2 dp)?
Now I wanted to understand why have they calculated asset beta formula as taking B co ungeared when it has specially said it is geared company.The asset beta measures the riskiness if there is no gearing.
Therefore we need to first calculate the asset beta of B (using the asset beta formula). Given that TR is moving into a similar market, the asset beta for TR will be the same as the asset beta for B.
Then we can calculate the equity beta to use by TR by using the asset beta formula again but using the gearing of TR.
I do work through a very similar example in my free lectures on CAPM and MM Combined.
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