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Hi Sir,
I was wondering with this question when calculating ungeared equity can you use the capm method? If so how as there is no premium but only rf? I guess you find premium by rm-rf but what is rm?
I find it easier to use capm but wasn’t sure how to as it doesn’t say on the answer as they have applied another method which I find more complex.
Thank you in advance
The answer has used the Modigliani and Miller formula (as provided on the formula sheet).
If you are good at algebra then you could in fact use ‘normal’ CAPM to find the current equity beta and then use the asset beta formula to get the ungeared (or asset) beta, and then use that to get the ungeared cost of equity. To do this you would need to use a symbol throughout for Rm (because it isn’t given) but Rm then disappears in the workings.
However, even if you are good at algebra this is all very messy and time consuming (and is effectively proving the MM formula). Much more sensible is to use the formula given and I do explain the formula and how to use it in my free lectures.
Hi,
Thank you for explaining. I will watch your lecture of MM as I struggled to understand it.
Thanks ?
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