6. You are trying to estimate the beta of a private firm that manufactures home
ID: 2819852 • Letter: 6
Question
6. You are trying to estimate the beta of a private firm that manufactures home appliances. You have managed to obtain betas for publicly traded firms that also manufacture home appliances. The private firm has a debt equity ratio of 25%, and faces a tax rate of 40%. The publicly traded firms all have marginal tax rates of 40%, as well. Firm Black & Decker 140 S 2,500 $ 3,000 Fedders Corp. 120 5 $200 Maytag Corp. 20 540 $2250 National Presto 0.70 $8 Whirlpool Beta Debt MV of Equity $300 150 $2900 $4000 a. Estimate the beta for the private firm using the bottom-up approach. b. What concerns, if any, would you have about using betas of comparable firms?Explanation / Answer
Unlevered Beta=Levered Beta/(1+(1-tax rate)*Debt/Equity)
Hence, Average Beta=(1.4/(1+(1-40%)*2500/3000)+1.2/(1+(1-40%)*5/200)+1.2/(1+(1-40%)*540/2250)+0.7/(1+(1-40%)*8/300)+1.5/(1+(1-40%)*2900/4000))/5=0.979764587
Beta for private firm=Levered beat=unlevered average beta*(1+(1-tax rate)*Debt/Equity)=0.979764587*(1+(1-40%)*25%)=1.126729275
The comparable firms might have different operating leverage
The comparable firms might be into diversified businesses and hence risk might be lesser.
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