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Good afternoon.
its not the arithmetic that is the issue in this. i have 1 observation/question:
we computed the asset beta of ‘other activities’ by replacing Ve with 75%Ve and Vd with 80%Vd. fair enough. and then we proceed to compute ‘component asset beta’, this is fine too.
when we calculate Tisa’s equity beta for component, we use Ve and Vd as given, ie full values.
it seems if we used proportions in Elfu’s Vd and Ve, i can make the argument that for tisa, the component business will also be some proportion of tisa’s Ve and Vd, and thus we shd have been given these proportions in order to compute the correct component equity beta for tisa.
i guess i am saying that we go thru the trouble of calculating asset beta for the component but in our equity beta calculation, we do not use any proportions since we are not told the proportions used in tisa.
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another way of thinking about it is that “had we been given the proportions for Vd and Ve in tisa for component business, our equity beta wd have been a more accurate estimate”
is this correct?
You are confused.
We ungear Elfu’s beta using Elfu’s gearing.
Then we work out the component asset beta using the fact that the total asset beta is the weighted average of the individual betas, and using 75% because it is equity that carries the risk, and 75% of Elfu is in other activities and 25% is in the component.
Then we take the compenent asset beta and use Tisa’s gearing to calculate the equity beta, hence the relevant cost of equity, and hence the WACC.
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