Task: Using the provided financial data from five publicly traded companies, compute the Unlevered Beta for the industry and adjust it to reflect the private company’s capital structure.
Step 1: Given Data for Peer Group
The following table presents the Levered Beta, Debt/Equity (D/E) ratio, and Tax Rate for five comparable companies.
| Company |
Levered Beta (βL) |
Debt/Equity (D/E) |
Tax Rate (T) |
| A |
1.3 |
50% (0.50) |
25% (0.25) |
| B |
1.5 |
80% (0.80) |
30% (0.30) |
| C |
1.2 |
40% (0.40) |
28% (0.28) |
| D |
1.6 |
100% (1.00) |
32% (0.32) |
| E |
1.4 |
60% (0.60) |
27% (0.27) |
Step 2: Calculating Unlevered Beta (βU)
The formula for Unlevered Beta is:
Show Unlevered Beta Formula
βU = βL / [1 + (1 - T) × (D/E)]
Using this formula, compute the Unlevered Beta for each company.
Step 3: Compute the Average Unlevered Beta
After calculating βU for each company, determine the industry average:
Show Industry Average Formula
Industry βU = (Σ βU of all companies) / Number of companies
Step 4: Adjusting to Target Capital Structure
The private company has a target D/E ratio of 70% and a tax rate of 30%. Adjust the Unlevered Beta using the following formula:
Show Relevered Beta Formula
βL = βU × [1 + (1 - T) × (D/E)]
Step 5: Compute the Cost of Equity Using CAPM
Once you have the new Levered Beta, compute the Cost of Equity using the CAPM formula:
Show CAPM Formula
Re = Rf + βL × Market Risk Premium
Assume:
- Risk-Free Rate (Rf) = 3%
- Market Risk Premium = 6%
Using these inputs, compute the Cost of Equity.