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The question provide :
Elfu Co :
Beta equity 1.4Other activities 1.25
Component division to compute.
Why the beta for the component division could not be a simple difference between 1.4 and 1.25, which is 0.15. and then calculate the beta asset using the component division capital structure of Elfu Co. Next compute the beta equity of tisa using tisa capital structure and the beta asset computed using the Elfu Co component division beta asset.
This when done gives a beta equity of 0.14 and the acca answer was 1.879.To note also acca answer Elfu Co total asset beta was 1.217 and the component division was1.634, other activities was1.07 when sum together (1.634 plus 1.07) is 2.704, which is higher by 1.487 (2.704 less 1.217) the total asset beta.
Kindly advice how the total asset beta is less than the divisons (component & other activities) when added .
You have obviously not watched the free lecture on CAPM, and I suggest that you do!
You cannot add two betas together. Beta measure the riskiness, and adding the betas together would mean that the total risk was greater than the risk of either of the two parts, which would be nonsense.
When two divisions are merged together, the beta of the whole is the weighted average of the individual betas.
Thank you sir. I will watch the presentation on CAPM shortly , as per your guidance.
Sir kindly assist how to apply inflation . I send my concern regarding question 2 June 2014 dated September 24, 2014 at 1.57 pm.
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With regard to the case of Elfu above, may I ask that is it possible to calculate the equity beta of Component this way:
Equity beta of Elfu as a whole equal to weighted average equity beta of component and other activities? 1.4 = 1.25* 75% + equity beta component * 25%
Then compute the asset beta of Component(ACCA’ answer based on weighted average asset beta).
Final answer WACC = 12.56% (ACCA 12.75%)
Many thanks
Tisa and Elfu have different capital structures (which will affect the equity beta). Otherwise it would have worked 🙂
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@johnmoffat said:
Tisa and Elfu have different capital structures (which will affect the equity beta). Otherwise it would have worked 🙂Clear now!
Thank you very much ?
May I ask if my method of estimation of Tisa Co Ke is correct?
Step1,calculate total Vd & Ve of Elfu Co
Step2,calculate Ve & Vd of other activities
Step3,calculate Ve & Vd of component production
Step4,calculate asset beta based of total company of Elfu Co and other activities
step5,since asset beta of the total company is a average weighted asset beta,then calculate asset beta of component production
Step6,using step5 result to get equity beta of Elfu co
Step7,by CAPM,estimate Ke of Elfu co
Step8,using Ke of Elfu co to get WACC of Tisa coI am a little confused that on step6&7,two companies hv the similar business risk,they hv the same asset beta or equity beta?
If two companies have similar business risk, then their asset betas will be the same. (Equity betas will be different because different levels of gearing result in different levels of risk for the shares).
With regard to standard deviations, because a normal curve is symmetrical 50% will be above the average and 50% below. For 99% confidence it is 99 – 50 = 49% on one side.
You then look ‘backwards’ through the tables to see how many standard deviations give an answer of 0.49 (49%). The nearest is 2.33 standard deviations.
Tisa Co.
Elfu Co Asset beta of other activities = 1,25 x $360m / (360+76.8 x (1-0.25))=1.078
My question is where did the $360m come from?
$76.8m looks like the 80% of $96m, but nothing was done with $96m w.r.t. Elfu co’s portfolio asset beta calculated just before that.I hope my question makes sense.
Thank you.
The question says that 75% of the equity is in other activities, so the 360 is 75% x 480.
And you are correct, because it says 80% of the debt is in other activities, the 78.8 is 80% x 96.
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