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How to calculate the beta of an unlisted company? (Unlevering and relevering of beta)
One can easily obtain the beta of a company that is publicly quoted in the market. The beta is available in the peer group of companies and it can be obtained easily. The beta calculations are required to determine the required cost of capital of the companies. These betas are, however, required to be adjusted for the varying leverage. This adjustment of leveraging is done through leveraging and unleveraging of the beta.
In determining the cost of capital via the Capital Asset Pricing Model (CAPM) in the context of valuation of corporate firms, it is stated that the cost of capital is composed of a tax-free rate and a risk premium which is equal to the market premium into beta. It is not problematic for publicly listed companies in the stock exchange. The beta values there can be obtained from the historical stock prices. These historical prices are available to all and can be accessed easily by investors.
How to Measure the Beta of an Unlisted Company?
If the beta of a firm that is not quoted publicly has to be determined, it will create an issue, as the historical prices are not available from the market. The issuance of stocks may not be applicable to such companies, and so, there is no question of historical stock prices being available. So, how can the beta values of such companies be measured?
To determine the beta values of non-listed companies, the peer groups of companies that are listed on the stock exchange are considered. That is, the companies that are comparable to the non-listed company but which are listed in the stock exchange are considered for calculation of the beta value of the unlisted company.
In order to apply betas from the market, there are two ways −
- Identical operating / industrial risk
- Identical average risk
The first condition can be fulfilled by choosing the peer group of companies that have identical attributes, such as operating margins, size or industry sectors. However, for the second requirement, if the peer group shows different degrees of debt ratios and hence different financial risks, the peer group beta has to be adjusted before applying it to the non-listed company. This is known and levering and unlevering of beta mathematically.
The sole purpose of levering and unlevering is to connect the beta of a listed company to that of an unlisted company. There are mathematical formulas to do this, and the process helps investors and tax professionals to identify the betas related to unlisted firms that may source debt from the market.
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