Onyx

Hi everyone

I have just studied the topic of Capital Asset Pricing Model and I am a little confused about the betas.

Kindly tell me does Equity Beta refers to the risk characteristics of an industry or a company. Or does Asset Beta refers to risk characteristics of an industry or a company or a project

Kindly also include your knowledge about asset beta and equity beta

ADBot

acca

i think it it explained well in ftc book.


Equity Beta measures the systematic business risk and financial risk of a company


Asset Beta measures the systematic business risk only



Systematic risk that relates to macro economic factors

Unsystematic risk is business related risk which can be reduced/eliminated thought diversification

Onyx

well that was a simple reference toward book statements but it isnt very helpful

actually i was having a problem while solving a question of Adjusted Present Value technique. in this question a company is considering diversifying in to the construction industry.

one para of that question is ;

"the construction industry has an average equity beta of 2.43 and its debt capital can be considered to be virtually risk free and so can be assumed to have a zero beta value. the average gearing (debt:equity) ratio in the industry is 3:4"

now solving this question , as we know for APV we assume that the company is ungeared and so the equity beta is equal to asset beta.

now in the solution of this question asset beta is calculated by using formula

asset beta = equity beta + [E/ E + D(1-t)]
= 2.43 + [4/ 4 + 3 (1-.35) ] tax rate is 35%
asset beta = calculate ur self


where E is market value of equity
D is market value of Debt
t is tax rate

equity beta and debt to equity ratio is taken from the above para and asset beta is calculated then as per the assumption being equal to equity beta it is put in the formula of CAPM to calculate cost of equity i.e.

cost of equtiy =risk free rate +(market rate of return - risk free rate) x equity beta

now this rate is used to discount the operational cash flows related to the project that company is trying to evaluate

my question is that in this question it is mentioned that equity beta is for an industry and you are saying it measures systematic risk of a company, so what does equity beta relates to actually , an individual company or the industry

and asset beta also ??



kindly answer if you can explain, dont just copy paste book lines , i already have a book

thanks

exzelert

Dear Onyx,

technically, u actually have the answer already.

since for APV question is assuming the company is ungeared and thus we have to find the asset beta of the company by using the equity beta of the industry.

that's why the equity beta of the industry = 2.43, is not equivalent to the asset beta of the company = 3.10.

to avoid confusion, from my understanding (based on my lecturer), using the CAPM formulae should be:

cost of equity (ungeared) = Risk free rate + (market rate of return - risk free rate) x [B]Asset beta

@

cost of equity = risk free rate + (market rate of return - risk free rate ) x equity beta.

note: although for ungeared company, the asset beta equivalent to equity beta, that does not mean that the equity beta of the industry equals to asset beta of the company.


hope this helps!