Page 113 - AFM Integrated Workbook STUDENT S18-J19

The weighted average cost of capital (WACC)

Use of the formula – degearing and regearing beta factors

Suppose a question tells you that the ABC company has a gearing ratio
(D : E) of 1 : 2, the shares have a beta value of 1.45 (the equity beta),
and the corporate income tax rate is 30%. Then:

Assume debt is risk free and debt beta is zero unless told otherwise.

β a = [2 /2+1(1–0.30)] × 1.45 = 1.074

Four very important implications:

1 a company's equity beta will always be greater than its asset
beta, except

2 if it is all equity financed (and so has no financial risk), when its
equity beta and asset beta will be the same.

3 companies in the same 'area of business' (i.e. same business
risk) will have the same asset beta, but

4 companies in the same area of business will not have the same
equity beta unless they also happen to have the same capital
structure.

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