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Hallo Sir,
I have two quick question on the above topic.
1)When using CAPM,my understanding is that you use the equity beta in the formula and not the asset beta.
I know that if you are investing in the different industry,you first have to ungear that industry beta and then regear it in our current gearing ratio to get the adjusted equity beta.
I have done two questions and they have used asset beta in the CAPM formula and im getting confused.My question is then how do I know when to use the Asset beta or equity beta in the CAPM?
2)In the question Neptune June 2008. A sentence in the question reads;
“Preconstruction and design costs incurred over the PREVIOUS 3 years total of 50m WILL BE CHARGED to the project in the first year”
Now maybe this is an English issue.To me that statement sound like they are commanding you to INCLUDE these costs despite what we know that we are not supposed to included such costs in the cashflows.
And indeed in the answer they have ignored the 50m as I would have done but the inclusion of the word “Will be charged ” made me think I MUST include them….So confused right now
1. It is always the equity beta that determines the cost of equity.
Without know which questions you are referring to, I can only guess that they are APV questions. In that case you initially discount the project at the cost of equity as if there is no gearing. If there is no gearing then the equity beta will be equal to the asset beta (and therefore the asset beta will determine the cost of equity)2 When they question says ‘they will be charged’ it mean that they will be charged for profit purposes. For profit purposes we can charge things any way we want, but for DCF purposes we are only concerned with the future cash flows that will occur if we do the project.
Thankyou Sir and yes it was APV questions. So I will only use the asset beta when doing APV questions.
And again, the profit issue clears things up .They are charging it for profit purposes not for DCF purposes. now it makes sense.
Thank you ????
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