Question

You are attempting to determine the beta of Corporation Z’s stock using the bottom up approach. Corporation Z’s D/E ratio is 0.3. You have identified the following firms operating in the same industry as Corporation Z:

Firm D/E ratio Statistical Beta

A 0.35 1.5

B 0.45 1.7

Assuming all firms are subject to a 21% corporate tax rate, please find the bottom-up (levered) beta for Corporation Z’s equity

Answer 1

Firm A

Levered Beta = Unlevered Beta x (1 + ((1 – Tax Rate) x (Debt/Equity)))

1.5 = Unlevered Beta*(1+((1-0.21)*(0.35)))

Unlevered Beta = 1.18

Firm B

Levered Beta = Unlevered Beta x (1 + ((1 – Tax Rate) x (Debt/Equity)))

1.7 = Unlevered Beta*(1+((1-0.21)*(0.45)))

Unlevered Beta = 1.25

Average unlevered beta = (1.18+1.25)/2= 1.215

Levered Beta = Unlevered Beta x (1 + ((1 – Tax Rate) x (Debt/Equity)))

levered beta = 1.215*(1+((1-0.21)*(0.3)))

levered beta = 1.5