Question one required candidates to calculate and comment on how the cost of capital of a company changes when it sells part of the business, to comment on the results and to explain any assumptions made.

Part (a) was generally done adequately. Most of the candidates calculated the initial cost of equity correctly, although a small minority confused the market risk premium with return on the market. Most candidates calculated the initial cost of debt correctly, but a few tried to estimate it using NPV and IRR which was not correct. Although many candidates estimated the market values of equity and debt correctly, a significant number assumed that the book value of debt was the market value of debt, and that free cash flows were the market value of equity.

Most candidates were aware that they needed to estimate a revised beta, once a part of the company was sold. However, a significant number found it difficult to un-gear the beta, find the asset beta for the hotel services only and thereby estimate an equity beta and cost of equity. Many candidates were unclear about the approach to be taken.

A sizeable minority of candidates did not comment on the results, nor explain the assumptions made in part (a). Since about 25% of the marks were allocated for these, candidates who did not comment or explain, were not gaining the maximum marks that were available.