MAGNITUDE OF HAVING TWO BETAS

Equity beta and asset beta are two different terms. The equity beta incorporates the risk in the capital
structure of the company (financial risk), while asset beta only incorporates business risk (the risk in the
industry due to the business environment and economic conditions) and so, the asset beta of companies
in the same industry will be the same since they have the same business risk. The Equity beta for an
entity is usually higher than the asset beta due to this inclusion of the financial risk. The consequence is
that; estimating cost of equity finance using asset beta will give a result less than the cost of equity
obtained using equity beta. Using the asset beta for a geared company will understate its risk and
therefore, its required return on equity finance.

However, it should be noted that it is not expected that the stock will have the same volatility in the
future.