4. Estimating Beta and Determining a Project Beta

i. calculate and interpret the beta and cost of capital for a project;

What is Beta (\beta)? The determination of cost of capital under the CAPM approach involves the estimation of β, risk-free rate, and market return. β is generally determined by comparing the return of the firm or the project (as the case may be) with the market return and ascertaining the relationship. The historical β is the first step in the determination of the ex-ante β. Either the historical β can be accepted as the proxy for the future β or modifications can be made to make it conform to the future.

What is the pure-play method of estimating Beta? The pure-play method can be used to take a comparable publicly traded company’s beta and adjust it for financial leverage differences.

What is the calculation to determine Beta of a levered firm? \(\beta_L = \beta_U(1 + \frac{(1 - T)D}{E})\)

What is the calculation to determine Beta of an unlevered firm? \(\beta_U = \frac{\beta_L}{1 + \frac{(1 - T)D}{E}}\)