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Chapter 18

9.1 CAPM and gearing risk

The CAPM uses a beta factor to represent the systematic risk levels of the
investment.

There are two types of beta factor:

Asset beta (β a) the beta for an ungeared company

Represents the systematic risk of the business type only
(business risk)

Equity beta (β e) the beta for a geared company

Represents both the business risk and the financial risk
(related to gearing levels) of the company

To use the CAPM to find a cost of equity for use in investment
appraisal, a beta with both the correct business risk (for the investment
type) and the correct financial risk (for the company undertaking the
investment) must be determined.

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