23 - market. The pure play approach or pure play method is...

Info iconThis preview shows page 1. Sign up to view the full content.

View Full Document Right Arrow Icon
Two firms in the same industry have very different equity betas. Offer two reasons why this can occur? Beta is an indirect measure, which compares the systematic risk associated with a company’s shares with the systematic risk of the capital market as a whole. If the beta value of a company’s shares is 1, the systematic risk associated with the shares is the same as the systematic risk of the capital market as a whole. Beta can also be described as ‘an index of responsiveness of the returns on a company’s shares compared to the returns on the market as a whole’. For example, if a share has a beta value of 1, the return on the share will increase by 10% if the return on the capital market as a whole increases by 10%. If a share has a beta value of 0.5, the return on the share will increase by 5% if the return on the capital market increases by 10%, and so on. Beta values are found by using regression analysis to compare the returns on a share with the returns on the capital
Background image of page 1
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: market. The pure play approach or pure play method is a method for estimating the cost of capital for a proposed new project or product line. It involves examining other companies, which are pure plays in the proposed line of business and inferring a cost of capital based on their capital structures (e.g., Debt-to-Equity ratio) and betas. Two firms in the same industry could have very different equity betas. One possibility is that the companies use different production technologies with different degrees of operating leverage. Operating leverage measures a firm's fixed versus variable costs. The greater proportion of fixed costs, the greater the operating leverage. Another is that the companies make different financing decisions, with one firm using more debt than the other. The firm using more debt financing will have a higher equity beta....
View Full Document

Ask a homework question - tutors are online