Question #15
Reading: Reading 17 Cost of Capital - Advanced Topics
PDF File: Reading 17 Cost of Capital - Advanced Topics.pdf
Page: 6
Status: Unattempted
Correct Answer: A
Question
In the process of estimating beta for a private company, unlevering the beta calculated for the publicly traded comparable company accomplishes what goal?
Answer Choices:
A. Establishing a baseline level of leverage
B. Improving the accuracy of the estimate in the event that the private company’s debt is of low quality
C. Isolating market risk
Explanation
Market risk, also known as systematic risk, is the risk common to all assets within a certain
class. Deleveraging the beta strips out the company-specific risk related to the target
company's leverage, thereby isolating market risk. Beta calculations do not require a
baseline level of leverage. The equation for calculating beta for private companies
assumes the company in question has high-grade debt. The deleveraging process will not
help if the assumption is incorrect.