Coc

[owaissikander]

t what point do we use the equity beta in calculating the cost of capital?

[Dagabie]

RE : COC

We use equity beta in calculating cost of capital at point where you want to established the correct equilibrium market value of a company's share.

You know there are some securities or investments which are risk free e.g. Government T'bills etc.

Some investments are also full of unavoidable business and financial risks (systematic risks), so lets assume after evaluating a plan to invest in the ordinary shares in a company called MBK LIMITED and have decided to invest in this company, the next thing to do is to calculate the NPV of returns from the equity. To calculate the NPV you would need to know the COST OF CAPITAL (DCF) to use. Therefore you need a formula which considers the risk of the investment and the sensitiveness of the returns of the company's ordinary shares to the changes in the systematic risks.

After the above exercise you would have come up with a cost of capital of the company's equity which takes account of the risk characteristics of the company's investment both business and financial risk.

We use Beta at a point when you want to include into the calculation of the cost of capital the volatility or sensitiveness of the returns of a company's shares to the changes in the risk factors.