An investment banker needs to calculate WACC for a private company that has no observable beta. The most appropriate approach is to:
- AUse a beta of 1.0 as a default assumption
- BUse the private company's accounting beta derived from historical financial statements
- CSkip the CAPM and use an arbitrary cost of equity based on investor expectations
- DUnlever comparable betas, then relever for the target✓ Correct answer
Why D — Unlever comparable betas, then relever for the target
The standard methodology for estimating beta for a private company is to use comparable public companies as proxies. The process involves: (1) identifying comparable public companies, (2) unlevering their observed betas to remove the effect of each company's unique capital structure, (3) calculating a median or mean unlevered beta, and (4) relevering that beta using the target private company's assumed capital structure. This approach isolates the business risk (unlevered beta) from financial risk (leverage) and applies the appropriate financial risk for the subject company.
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