fair enough this is your comparable beta equity

how much is this 5 percent

how much is this 2 percent let me just pause here for a second and say this

example is very simple in terms of numbers

but the methodology is what you want to focus on

the numbers are simple so that we you know you can get

moving fast the second question beta equity

do not pull from Yahoo Finance try to be very

make sure you’ve the best beta for this

business and Morningstar is a great company other companies also do this

very well

but it’s statistical beta is a statistical

number so Re is seven-percent are we in business now

yes so to make sure we have everything going right

let’s start I will substitute all the numbers

7 percent for here

2 percent for here D what let's go through it again

this is 30 .34

120

when you do that you will figure out Ra

will work out to be 6.3

6.3 percent please

take a while and do it once I'm done I'm not going to walk through the steps I’ve just

put in all the numbers so 7 percent times 120

divided by 30

times .34 subtracted from one

plus 120 and so on so just very quickly if you do this

you'll be able to get exactly what I have done here and you’ll get 6.3 percent

but what is 6.3 percent the return on

the business

of that’s your comparable there

one more step and then we'll take a little break so we have done

return on assets and it’s 6.3 percent

I have given all the numbers and I would really encourage you to kinda do the

mechanical calculations to make sure 6.3 is right

every time you have a debt number on the right hand side

please remember that it has to be multiplied by 1 minus TC

let's now do for complete for

getting a complete picture of it and let's do

beta assets

remembering we are still in approach one

so return on asset is 6.3 percent

what is the comparable beta asset remember

going through the steps again beta asset the neat

thing is

all these things that I'm writing

are basically the same right

beta debt actually plus

E over D 1 minus

TC plus E beta

equity so I'm saying now let's go through these steps and see if we can figure out

what beta asset is for our comparable

using approach one do I know D

yes do I know E yes do I know TC yes

so .34

120 30

those are the three numbers again 120

30 .34

do we know beta equity did I give you this beta equity or not

the answer is yes beta equity was

one right

where did we use this beta equity earlier

we used this beta equity through CAPM to get a return on asset

which was about I mean return on equity which was about 7 percent

I think I'm slipping up today for some reason asset equity I’m

confusing the two okay but the challenge here

is to figure out beta debt which we already have figured out

and it’ll be 0 so the answer to this will work out to be

.86

the reason I can do it so easily is because I've done it already

just so that you know the way I know it’s .86 is I’ve

done the rates and this is zero so that tells me also

what is this rate going to be if I’ve calculated it

right .86

then what will this rate be

point .14 key to remember

very very common in our applications in books

in student thinking they think this is always true

and what is this that the beta of debtis 0

this is derived from the assumptions made I think I’ve

told you this and Modigliani-Miller which is the basis of

a lot of finance that at some point made an assumption for ease

that suppose that all debt is risk-free

and therefore beta debt disappeared from the equations and therefore

you know a lot of people assume that's always true not true

we know how to do beta asset and beta equity

approach which one one

Re 6.3 beta Ra 6.3

beta a .86 watch me today

my language is going flip flop sometimes okay

so let's do now next approach

two what is the return on asset using approach two

now this is becoming a little bit repetitive

but it's very careful to know both methods the method two what is the assumption

method two the assumption is tax shield is using what as the discount rate

Ra so let’s write out Ra

Ra is equal to D over D plus E and now I feel good

because there's no 1 minus TC floating around Re

plus E over D plus E

Rd yes cool

have I screwed up something yes I did

I'm today going back and forth

between these Rs for some reason okay so

if I’m doing it fast at least I’m catching it so every time you have a proportion of debt

you should have a return on

debt and so on why does this equation work we have

done that that's a proof we've done already let's plug and chug

30 30

120 120

30 120

okay so which has more weight clearly

more weight is on equity right we knew that

what is Rd we already went through the process of realizing that beta debt is

zero the

Rd has to be the risk-free rate what is Re

Re was

7 percent how did we get that

beta equity was one in CAPM and so on

so these are just essentially the weights are changing

because of the assumption of the tax deductibility

the weights are 80 20 here and they were 86

14 earlier what does this number work out to be

well this number works out to be 6 percent

please confirm that this is true and if you hear a little paper

rustling it’s me confirming that this is true

okay so we have done return on assets

its lower a little bit 6.36 percent

okay let's beta of assets using this approach

beta of assets using this approach is pretty straightforward

D over D plus E beta D

plus E over D plus E

beta E what do we know in this equation

well we know that this is 20 percent

this is 80 percent 120 divided by

150 I think is 80 percent or point 80

what is this 0 what is this 1

how do we know that we've already given it can we figure it out for bears

ourself

yes by estimating it using regression

methodology this turns out to be .8

so I'm going to take a pause but before

I do so I’ll remind you that there are two pairs of

Ras and beta As approach one

approach two and what are the pairs

6.3 percent Ra

with the beta a .86

6 percent with the beta of

.8 approach two approach

one does this make sense

always ask yourself equations are all fine I know the logic blah blah blah but

the numbers should make logic too and the answer is I think they do

why because as the beta increases

what happens to the return the return also goes up

and why are they different they are simply different because of the

assumption about the discount rate for the tax shield

let's take a break and when we come back

we will take all this information and actually do some fun

valuation