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Quiz question Cost of Equity

Forums › Ask ACCA Tutor Forums › Ask the Tutor ACCA FM Exams › Quiz question Cost of Equity

  • This topic has 5 replies, 3 voices, and was last updated 10 years ago by John Moffat.
Viewing 6 posts - 1 through 6 (of 6 total)
  • Author
    Posts
  • November 30, 2014 at 11:24 am #214704
    Stefano
    Member
    • Topics: 23
    • Replies: 28
    • ☆☆

    Hi,

    Would you mind helping me with this question?

    AJT has a gearing ration debt: (debt+equity) of 30% and pays corporate tax 25%
    AJT has an asset (ungeared) Beta of 1.2. the risk free is 5% the market return of 12%

    What is the cost of equity?

    answer: 16.10%

    I need to see the calculation as I couldn’t calculate the geared beta from above information to apply to the CAPM

    Thank you in advance,

    SP

    November 30, 2014 at 3:30 pm #214764
    John Moffat
    Keymaster
    • Topics: 57
    • Replies: 54679
    • ☆☆☆☆☆

    For every 30 debt there is 70 equity.

    So the asset beta = (70 / (70 + (30 x .75)) x equity beta

    We know the asset beta is 1.2, so using the above equation gives an equity beta of 1.586

    It is the equity beta that determines the shareholders required rate of return and therefore the cost of equity.

    So the cost of equity = 5% + 1.586 (12% – 5%) = 16.10%

    November 30, 2014 at 4:41 pm #214790
    alua
    Participant
    • Topics: 28
    • Replies: 37
    • ☆☆

    Sorry but I still cannot get it! I did exactly the same but (forgive me if its just a calc what I am not doing right) but my equity beta = 0.908 (1.2 x (70/(70+(1-0.25))))
    Thanks

    November 30, 2014 at 4:52 pm #214793
    John Moffat
    Keymaster
    • Topics: 57
    • Replies: 54679
    • ☆☆☆☆☆

    You are not reading the formula properly.

    1.2 = (70/(70+(1-0.25))) x beta equity

    So beta equity = 1.2 x (70 + (30 x 0.75)) / 70) = 1.586

    November 30, 2014 at 4:53 pm #214794
    alua
    Participant
    • Topics: 28
    • Replies: 37
    • ☆☆

    I beg your pardon! Error in calc as I thought! I understand now, sorry.
    Many thanks!

    December 1, 2014 at 8:07 am #214960
    John Moffat
    Keymaster
    • Topics: 57
    • Replies: 54679
    • ☆☆☆☆☆

    No problem 🙂

  • Author
    Posts
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