When valuing a firm you plan to acquire by buying all of its equity, you should
ID: 2743228 • Letter: W
Question
When valuing a firm you plan to acquire by buying all of its equity, you should use:
Unlevered beta to calculate its cost of equity.
Its current market beta to calculate its cost of equity.
Use a cost of equity estimate based on the capital structure you are going to use going forward.
Use dividends-based valuation model using its existing cost of equity.
Unlevered beta to calculate its cost of equity.
Its current market beta to calculate its cost of equity.
Use a cost of equity estimate based on the capital structure you are going to use going forward.
Use dividends-based valuation model using its existing cost of equity.
Explanation / Answer
Its current market beta to calculate its cost of equity
Capital Asset Pricing Model is used to compute the cost of equity of the firm.
Cost of equity = Rf + (Rm- Rf) x beta
The value of all variables in CAPM model keeps changing with time. Therefore, it is essential to use the current values to compute the cost of equity. This is why current market beta of the firm is used to compute the cost of equity.
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