Forums › Ask ACCA Tutor Forums › Ask the Tutor ACCA FM Exams › Help beta working- question 9 Pre Sept mock exam

- This topic has 3 replies, 2 voices, and was last updated 3 weeks ago by LMR1006.

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- September 2, 2023 at 4:28 pm #691189
Hi,

I am struggling to understand how the answer for Step 1 in this question is calculated.

The answer I get is “2” for step one. My working is from the inside brackets to outside brackets and then x / + – , could you please help with where I’m going wrong, I can’t get the answer 1.304.

Question:

South Co is a private company that wants to establish its cost of equity in order to evaluate a new investment proposal. North Co is a listed company that is very similar to South Co.

South Co has a debt:equity ratio of 1:3

North Co has a debt:equity ratio of 1:4

North Co’s equity beta is 1.50

Corporation tax is 40%

Calculate an appropriate beta for South Co to use in its cost of equity calculation to 2 decimal places.Answer:

Step 1 – estimate an ungeared (asset) beta from North

Co’s equity beta

Assuming a debt beta of zero:

Ba = Be (Ve/(Ve+ Vd(1-T))

Ve = value of equity

Vd = Value of debt

T = rate of tax

Ba = 1.50 x 4/(4 + 1 (1-0.40)) = 1.304Step 2 – estimate the geared (equity) beta for South Co

Be = Ba (Ve+ Vd(1-T)Ve)

= 1.304 × (3+1 (1-0.40)/3)

=1.56September 2, 2023 at 8:35 pm #691202The answer is beta asset = beta equity * ( E / ( E * D(adj for tax))

So in other words it is Ba = 1.50 * (4 / 4.6) as you must work out Debt first then add it to equity – so 1 * 0.6 + 4 = 4.6

That gives you the bottom part of the formula

Then 4 / 4.6 gives you 0.8695 then multiply by 1.25 which results in 1.304

Hope that answers your question

You have to work out D (adj for tax), then calculate D+EThen divide E by (E + D(adj for tax))

Then multiply by Be to get Ba

September 3, 2023 at 11:37 am #691239Hi, thank you so much for the response, makes sense. I will keep practicing 🙂

September 3, 2023 at 10:46 pm #691264You are welcome :0-)

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