April 2014
Intermediate to advanced
1344 pages
44h 24m
English
book
Cost of Capital: Applications and Examples, + Website, 5th Edition
by Shannon P. Pratt, Roger J. Grabowski, Richard Brealey
Content preview from Cost of Capital: Applications and Examples, + Website, 5th Edition
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CHAPTER 12
Unlevering and Levering Equity Betas1
Formulas for Unlevering and Levering Equity Betas
Practitioners' Method Formulas
Adjusting Formulas for Other Components of Capital Structure
Choosing among Unlevering and Levering Formulas
Adjusting Asset Beta Estimates for Differences in Operating Leverage
Adjusting Asset Beta Estimates for Excess Cash and Investments
INTRODUCTION
Published and calculated betas for publicly traded stocks typically reflect the capital structure of each respective company. These betas are sometimes referred to as levered betas, that is, betas reflecting the leverage in the company's capital structure.
Levered betas incorporate two risk factors that bear on systematic risk: business (or operating) risk and financial (or capital structure) risk. Removing the effect of financial leverage (i.e., unlevering the beta) leaves the effect of business risk only. The unlevered beta is often called an asset beta. Asset beta is the beta that would be expected were the company financed only with equity capital. When a firm's beta estimate is measured based on observed historical total returns (as most beta estimates are), its measurement necessarily includes volatility related to the company's financial risk. In particular, the equity of companies with higher levels of debt is riskier than the equity of ...
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