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Chapter 10

6.4 Asset betas, equity betas and debt betas

In order to calculate cost of equity and/or WACC for use in business
valuation, we first need to expand our understanding of beta factors.

The beta factor is a measure of the systematic risk of an entity relative
to the market.

This risk will be dependent on the level of business risk and the level of
financial risk (gearing) associated with an entity.

Hence, the beta factor for a geared company will be greater than the
beta factor for an equivalent ungeared company.

The relationship between the beta factors for ungeared and geared
companies is given by the following formulae (given in the exam):

V E V [1 – t]
D
ß = ß [ ] +ß [ ]
eu eg V + V [1 – t] d V + V [1 – t]
D
D
E
E
V [1 – t]
D
ß = ß + [ß – ß ] [ V ]
eg
d
eu
eu
E
where:

ß eg = the equity (geared) beta measures the systematic business risk and the

systematic financial risk of a company's shares
ß eu = the asset (ungeared) beta measures the systematic business risk only
ß d = the debt beta measures the risk associated with the debt finance. Usually we

assume that debt is risk free and hence the debt beta is zero.

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