Question thread (for March attempt), problems encountered while attempting Qs.

[nikaido]

Dear, Mr Moffat

I am required to find cost of equity ( systematic risk only for specific project ) The similar company details given below has the element of gearing so the cost of equity required would deffinately below 14 % .. The answer is 10 % , but i couldnt comprhend the answer given in the kit . Kindly would u walk me through. Was expecting betas to be ungeared but this is something new i have encountered so far.

Haizum Co, a listed company, produces
electrical-powered vehicles using similar technology to that required for the mobility vehicles. Haizum Co’s cost of
equity is estimated to be 14% and it pays tax at 28%. Haizum Co has 15 million shares in issue trading at $2.53
each and $40 million bonds trading at $94.88 per $100. The five-year government debt yield is currently estimated
at 4.5% and the market risk premium at 4%.

[John Moffat]

You can get the answer two ways.
Either use the M&M formula (the first one on the formula sheet) or calculate the geared beta, ungear it, and then use the ungeared beta to calculate the cost of equity. Both ways will give the same answer, and I explain both ways in my free lectures.

Using the first way,

14% = Ke + 0.72 x 37.952/37.95 x (Ke – 4.5%)
14% = 1.72Ke – 3.24%
17.24% = 1.72Ke
Ke = 17.24/1.72 = 10%

[nikaido]

Thank u ,.. i skipped the 94.88 detail and was quick to ask here right away .. thought this didnt get posted here .. so i was able to do it in the conventional way .. thanks for pasting the M and M way of solving caz i had left it for later to be covered.

[John Moffat]

You are welcome 🙂

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