I have a doubt in the last question, ie. Q17. Here, in the solution provided, they have kept the beta constant throughout the question. It has not varied even when new debentures are issued. Doesn't the beta has to change with the gearing. Please help me with this.
Just reframing the question We know that the beta of the company is affected by it's gearing. So as new debentures are issued we must calculate the new geared beta (by first finding ungeared and then newly geared beta) to carry on further with the calculations. But it's not done like this in the solution.
It would seem the solution has made an (unstated) assumption that the existing cost of equity and existing cost of debt are unchanged as a result of the new issue. The change to the cost of equity could be determined using the standard beta adjustment formula. If this was used I don't think the WACC will ever reduce to 7%.
