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Hello.
I am going through the kaplan revision kit and there is question on cost of capital by the name of GM Co on page 52 which is giving me trouble. In part b of the question we are asked to calculate risk adjusted cost of equity, in your lectures on the topic you said just ungeare beta by using formula and then put the ungeared beta into capm and get the cost of equity. In the kit they have done an additional step and further adjust the beta into GM Co debt/equity ratio and i am confused about why they have done it ,as there is nothing about this step in OT notes or lectures . Any help would be appreciated . ThanksWhen you ungear the beta, the beta is for an ungeared company. But if you are finding the cost of equity of a geared company, you will have to regear back according to the capital structure of the said company. You just cannot use the ungeared beta to calculate the cost of equity of a geared company.
What Ramesh says is correct. Using the ungeared/asset beta gives the cost of equity if there was no gearing.
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