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Sir, one quick question
Why isn’t MV of Debt(Vd) of each company taken into consideration when calculating the asset beta for the combined company? Please advise.
We are told in the question what the asset betas are for the two companies. The asset beta for the combined company is (as I explain in my free lectures) the weighted average of the two individual asset betas.
The market value of debt is only then relevant when using the asset beta formula in order to calculate the equity beta for the combined company from the asset beta.
So in order to calculate the overall Beta asset of the combined company, we first take the individual asset beta of each company and multiply with equity finance( because it is equity finance that carries the business risk) proportion for each company.
This scenario is somewhat similar to the asset beta computation of the component division in the Question:TISA Co ( June 2012/ BPP 14). Am I right?
Pls correct me if my understanding on above is incorrect?
Thanking you in advance for your explanation.
Your understanding is correct. However the weighting to use really depends on the wording of the question. This question assumes that it is the equity that carries the risk (as is sensible) but other questions have specifically said to use different weightings (such as the value of the assets). It is not a problem to worry about but does emphasise the need to read the question carefully 🙂
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