Topic 34
Beta Application in Determination of CU
Topic 34 explores the application of beta in the determination of CU, the unlevered cost of equity capital, which is the appropriate discount rate for the valuation of free cash flow in leveraged buyouts and highly leveraged transactions.
- If the acquisition of the target is to be valued as a leveraged buyout transaction where the unlevered free cash flows are valued separately from the value of debt employed, the unlevered beta is used without releveraging in the determination of the target's CU using the capital asset pricing model (CAPM), as shown in Illustration 34.1.
Illustration 34.1 CAPM Determination of CU (for Valuation of Unlevered Enterprise Valuea)
aAll percentage values indicated are for illustration clarity only. The amounts used are not static and should reflect the most current data available at the time of CAPM construction.
bFrom an analysis of comparable companies, see Topics 29, 32, and 33.
cSize premiums vary in amount (see Topics 23 and 36).
- A frequently used source for risk-free rates, beta, and size premium data is from Ibbotson Associates, Chicago, Illinois, a subsidiary of Morningstar, Inc., which provides and updates these data annually, provides exceptionally well-documented literature, and provides a Web site source (www.ibbotson.com).
- See Topics 43 and 44 for an illustration of how CU is used in ...
