Series 79 practice questionhardWACC and Cost of Capital
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 the betas of comparable public companies, calculate a median unlevered beta, and relever it using the private company's target capital structure✓ Correct answer
Explanation
Why D — Unlever the betas of comparable public companies, calculate a median unlevered beta, and relever it using the private company's target capital structure
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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