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Hi John,
I am stuck on the question below
“Stetson Plc is a passenger airline which has a debt: equity ratio of 1:1. It wishes to expand into air freight and has identified that the beta of a highly geared parcel delivery company has a beta of 1.8 and Ke of 18.4% – these are influenced by its gearing of 2:1 debt to equity. Assume that debt has a beta of zero”
Calculate the Cost of capital that Stetson should use to appraise this investment by ungearing and regearing the beta.
Ungearing the beta
The answer in the workbook gives ba = 1.8 (1/24) = 0.75Can you explain where they got the 1/24 from please?
Thanks
ElizaI am sorry but I have no idea where they got 1/24 from and I assume that it is a typing mistake (because obviously 1.8(1/24) does not equal 0.75 !!
It is 1/2.4 and although you have not written the rate of tax I would guess that it is 30%. In which case Ve + Vd (1-T) = 1 + (2×0.7) = 2.4.
Have you watched my free lectures on this? 🙂
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