Question 1

Section A

LexAI, an AI-driven legal services firm, is entirely equity financed with an equity beta of 1.4. It plans to diversify into a new industry (cloud data storage) and has identified a proxy company in that industry. The proxy company has an equity beta of 1.2 and a debt-to-equity ratio of 1:3 by market value. The corporate tax rate is 25%.

What is the asset beta of the proxy company? (Round to two decimal places)

Accepted Answer

Use the asset beta formula: Ba = Be * [Ve / (Ve + Vd(1-T))]. The proxy company's D:E is 1:3, meaning Vd = 1 and Ve = 3.

Question 2

What mistakes do candidates make on this ACCA question?

Accepted Answer

Using LexAI's equity beta (1.4) instead of the proxy company's beta, or misinterpreting the D:E ratio of 1:3 as Ve=1, Vd=3.

How to approach this question

Full Answer

Common mistakes

Practice the full ACCA FM — Financial Management Practice Exam 6

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