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Hello Sir,
When do we use the Ungeared cost of capital (kei)? I know we will need to use the formula to find it but is it when the questions states that the finance is raised through all equity. Sometimes uses the asset beta = Equity beta too. Please can you help to explain the difference?
Many thanks in advance!
If there is no gearing then the only risk is the risk of the business and therefore the equity beta will equal the asset beta (the asset beta measures the risk of the business).
If there is gearing the company, then the gearing creates more risk for the equity and therefore the equity beta will be higher than the asset beta (the equity beta measures the riskiness of the shares).
I do explain all of this in my free lectures on CAPM.
Hello, thank you for replying back. Please can you help to explain the reasoning for asset beta used in Q23 Amberle (Dec2018).
VS
In Fubuki Co (Dec10), why did they use Ungeared cost of equity?
In Amberle the question asks for an APV approach and so the base case NPV is calculated using the ungeared cost of equity. The equity beta if there is no gearing is the same as the asset beta and so it is the asset beta of 1.14 that is used to calculate the ungeared cost of equity.
In Fubuki, again we are taking an APV approach and therefore using the ungeared cost of equity. (The question does not specifically say to take an APV approach, but the information does indicate this – particularly since there is a big change in the gearing.)
Have you watched my free lectures on CAPM and APV?
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