Work out the cost of debt or equity investors' required return for both a listed and a privately held company
The idea
For a public company, apply the methods directly: yield on its traded bonds for the pre-tax cost of debt, and the CAPM using its own beta and an equity risk premium defined as market return minus the risk-free rate. For a private company, borrow a beta from listed peers: unlever it with βU = βE ÷ [1 + (1 − t) × D/E], then relever at the target structure with βE = βU × [1 + (1 − t) × D/E]. Add size and company-specific premiums where justified, and estimate the cost of debt from a synthetic rating or bank rates. Traps include multiplying beta by the market return rather than the premium, and skipping the (1 − t) term.
In the app: 2 practice questions on this outcome, a narrated walkthrough with diagrams, spaced review that brings it back before you forget it.
Take the free diagnostic →More in Cost of Capital: Advanced Topics
- Set out the top-down and bottom-up influences on a firm's cost of capital
- Contrast the approaches for estimating what debt costs a firm
- Set out how an equity risk premium can be estimated from past data or from forward-looking inputs
- Contrast the approaches for estimating equity investors' required return
- Benchmark a company's cost of capital and capital structure against those of its peers