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However, business risk is specific to a project, so when
investing in projects with different business risk a marginal
cost of capital (using the CAPM) should be used. It is
inappropriate to use the current WACC.
Step 1 – find a quoted in that business
An equity beta is the beta of a share, and will be an indication of the
risk of the business.
Step 2 – adjust the beta to reflect differences in gearing
In reality an equity beta will be also be affected by a ’s
gearing. To understand the level of business risk the equity beta needs
to be adjusted by strip out the effect of gearing to create an
ungeared or an asset beta – this measures business risk.
Step 3 – use the re-geared beta to calculate an appropriate cost of
capital
Lecture Example
TR Co has a gearing level of 1:3 debt : equity. TR is considering
diversifying into a new market. B Co is already operating in the new
market. B Co has an equity beta of 1.05 and a gearing level of 1:4 debt :
equity. Both companies pay 30% corporation tax.
The risk rate is 4% and the market premium is 4%.
What is TR Cos cost of equity for assessing the decision to diversify
into the new market?
Answer
B Co is being used as a and has a different level of
gearing to TR Co.
Ungear B Cos equity beta:
Regear ßa using TR assumption of a gearing level of 1:3 debt : equity
Ex1 –201412Q1 商业风险 的思想
Fugae Co repairs and maintains aircraft engines. Now
Fugae Co is considering entering a growing market for
luxury travel through a four-year project
Although there is no beta for companies offering luxury
forms of travel in the tourist industry, Reka Co, a listed
, offers passenger transportation services on
coaches, trains and luxury vehicles. About 15% of its
business is in the luxury transport market and Reka Co’s
equity beta is 1·6. It is estimated that the asset beta of the
non-lux
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