Question 1

CASE 2: AERODRONE TECH

AeroDrone Tech is an ungeared manufacturer of commercial delivery drones. The company currently has a cost of equity of 12%. The board is considering a major restructuring to issue debt and repurchase equity. The corporate tax rate is 25%. The risk-free rate is 4% and the equity risk premium is 6%.

Using the Capital Asset Pricing Model (CAPM), what is AeroDrone's current asset beta (ungeared beta)?

Accepted Answer

Rearrange the CAPM formula: Ke = Rf + Beta(Rm - Rf). Note that (Rm - Rf) is the Equity Risk Premium. Solve for Beta.

Question 2

What mistakes do candidates make on this ACCA question?

Accepted Answer

Adding the risk-free rate to the equity risk premium to find Rm, then using Rm instead of the premium in the formula.

How to approach this question

Full Answer

Common mistakes

Practice the full ACCA FM — Financial Management Practice Exam 3

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