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The Harris & Pringle formula for leveraging the asset beta, to obtain the equity beta, has been used in
the simplified Brennan-Lally CAPM.
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We note that, as leverage increases, the debt premium should also increase. However, such increase is
difficult to model as the function would be non-linear.
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The traditional formula (Hamada) for leveraging the asset beta, to obtain the equity beta, has been
used in the classical CAPM.
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Assuming 7% for the TAMRP is consistent with the Commission’s straw person example. We
derived the MRP for the classical model applying the following calculation: MRP = TAMRP – Rf(Ti),
i.e. 5.4=7-5.36*0.3.
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Figure 1: Effects of Changes in Leverage on Post-tax WACC
Brennan-Lally versus Classical CAPM
7.75%
7.50%
7.25%
Post-Tax WACC
7.00%
6.75%
6.50%
20% 30% 40% 50% 60% 70%
Leverage
Brennan-Lally Classical
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http://www.comcom.govt.nz/IndustryRegulation/Part4/DecisionsList.aspx
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Figure 2: Effects of Changes in Leverage on Cost of Equity
Brennan-Lally versus Classical CAPM
14%
12%
10%
Cost of Equity
8%
6%
4%
2%
0%
20% 30% 40% 50% 60% 70%
Leverage
Brennan-Lally Classical
For details of the formulae applied in the current analysis, please refer to Appendix 1.
For details of all parameter estimates, please refer to Appendix 2.
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APPENDIX 1
Formulae used
Where
rd is the cost of debt capital
re: is the cost of equity capital
Tc is the corporate tax rate
L: is leverage
Classical
rd = rf +p
re= rf+ βe ×MRP
βe= βa + βa (1- Tc) ×L/(1-L)
Where
MRP is the market risk premium
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APPENDIX 2
Details of Parameter Estimates