Lecture 3
Implied Equity Premiums
Gordon Growth Model:
• Value = Expected Dividends next year/ (Required Returns on Stocks - Expected
Growth Rate)
Beta levered / unlevered
Bottom-up Betas
Steps in bottom-up Beta
◼ Identify business areas
◼ Find competitors in these business areas and their regression beta
◼ Calculate the average unlevered beta for the competitors
◼ Calculate unlevered beta for your business
◼ Calculate the levered beta for your business
Bottom-up beta is taking the whole industry and calculating the beta of the average
beta.
Bottom-up provide a better value for true beta than regression beta because:
- it has lower STD
- It takes into account the company’s current product mix and debt / equity ratio
- it can be used for different business areas and unlisted companies
CAPM
, What should you choose for CAPM?
CAPM can be very different depending how you calculate the numbers. The
difference can be 4.51% or 12.87% return.
We should use the geometric average when calculating the mean.
Cost of debt
◼ Observe the general level of interest rate
◼ Assess the company's risk profile
◼ Determine the company tax rate (or use a standard tax rate for the cash flow)
The cost of debt is not the rate at which you borrowed money historically, it is the
rate you borrow the money for today.
This cost reflects not only interest rates but also the risk of bankruptcy for the
company.
The most widely used methods to calculate the cost of debt capital are:
▪ Using the interest rate on an existing bond recently issued by the company
(corporate bond)
▪ Study the credit rating of the company and thereby obtain bankruptcy risk based on
this credit rating.
Implied Equity Premiums
Gordon Growth Model:
• Value = Expected Dividends next year/ (Required Returns on Stocks - Expected
Growth Rate)
Beta levered / unlevered
Bottom-up Betas
Steps in bottom-up Beta
◼ Identify business areas
◼ Find competitors in these business areas and their regression beta
◼ Calculate the average unlevered beta for the competitors
◼ Calculate unlevered beta for your business
◼ Calculate the levered beta for your business
Bottom-up beta is taking the whole industry and calculating the beta of the average
beta.
Bottom-up provide a better value for true beta than regression beta because:
- it has lower STD
- It takes into account the company’s current product mix and debt / equity ratio
- it can be used for different business areas and unlisted companies
CAPM
, What should you choose for CAPM?
CAPM can be very different depending how you calculate the numbers. The
difference can be 4.51% or 12.87% return.
We should use the geometric average when calculating the mean.
Cost of debt
◼ Observe the general level of interest rate
◼ Assess the company's risk profile
◼ Determine the company tax rate (or use a standard tax rate for the cash flow)
The cost of debt is not the rate at which you borrowed money historically, it is the
rate you borrow the money for today.
This cost reflects not only interest rates but also the risk of bankruptcy for the
company.
The most widely used methods to calculate the cost of debt capital are:
▪ Using the interest rate on an existing bond recently issued by the company
(corporate bond)
▪ Study the credit rating of the company and thereby obtain bankruptcy risk based on
this credit rating.
