{"id":2670,"date":"2019-09-12T17:42:00","date_gmt":"2019-09-12T17:42:00","guid":{"rendered":"https:\/\/analystprep.com\/cfa-level-1-exam\/?p=2670"},"modified":"2026-03-08T10:02:02","modified_gmt":"2026-03-08T10:02:02","slug":"beta-cost-capital-project","status":"publish","type":"post","link":"https:\/\/analystprep.com\/cfa-level-1-exam\/corporate-finance\/beta-cost-capital-project\/","title":{"rendered":"Beta and Cost of Capital of a Project"},"content":{"rendered":"\n<script type=\"application\/ld+json\">\n{\n  \"@context\": \"https:\/\/schema.org\",\n  \"@type\": \"VideoObject\",\n  \"name\": \"Cost of Capital (2021 Level I CFA\u00ae Exam \u2013 Reading 33)\",\n  \"description\": \"This video lesson covers the cost of capital, explaining weighted average cost of capital (WACC), capital structure, marginal cost of capital, and investment opportunity schedules. It details debt, preferred, and common equity costs using CAPM, dividend discount, and bond yield approaches, including flotation costs and project risk adjustments.\",\n  \"uploadDate\": \"2018-11-21T00:00:00+00:00\",\n  \"thumbnailUrl\": \"https:\/\/img.youtube.com\/vi\/I_SgGrDv1YM\/maxresdefault.jpg\",\n  \"contentUrl\": \"https:\/\/youtu.be\/I_SgGrDv1YM\",\n  \"embedUrl\": \"https:\/\/www.youtube.com\/embed\/I_SgGrDv1YM\",\n  \"duration\": \"PT33M52S\"\n}\n<\/script>\n<script type=\"application\/ld+json\">\n{\n  \"@context\": \"https:\/\/schema.org\",\n  \"@type\": \"QAPage\",\n  \"mainEntity\": {\n    \"@type\": \"Question\",\n    \"name\": \"What is Company PQR\u2019s equity beta given its capital structure and tax rate?\",\n    \"text\": \"Company PQR is in the telemarketing business. The asset beta for a comparable company in the same industry is 1.3. If Company PQR\u2019s debt-to-equity ratio is 1.2 and the corporate tax rate is 35%, what is Company PQR\u2019s equity beta?\\n\\nA. 1.65\\nB. 2.31\\nC. 2.58\",\n    \"answerCount\": 3,\n    \"acceptedAnswer\": {\n      \"@type\": \"Answer\",\n      \"text\": \"B. 2.31\\n\\nExplanation: The equity beta is calculated by relevering the asset beta using the formula \u03b2L = \u03b2A \u00d7 [1 + (1 \u2212 t)(D\/E)]. Substituting the given values: \u03b2L = 1.3 \u00d7 [1 + (1 \u2212 0.35) \u00d7 1.2] = 1.3 \u00d7 (1 + 0.78) = 2.31.\"\n    },\n    \"suggestedAnswer\": [\n      {\n        \"@type\": \"Answer\",\n        \"text\": \"A. 1.65\"\n      },\n      {\n        \"@type\": \"Answer\",\n        \"text\": \"C. 2.58\"\n      }\n    ]\n  }\n}\n<\/script>\n\n\n\n<p>\n  <iframe loading=\"lazy\"\n    src=\"\/\/www.youtube.com\/embed\/I_SgGrDv1YM\"\n    width=\"611\"\n    height=\"343\"\n    allowfullscreen=\"allowfullscreen\">\n  <\/iframe>\n<\/p>\n\n\n\n<p>When estimating the cost of equity using the Capital Asset Pricing Model (CAPM), a reliable estimate of beta must be used.<\/p>\n\n\n\n<p>The beta for a company that is not publicly traded may be estimated using the pure-play method. In the pure-play method, the starting point is the beta for a comparable publicly traded company, i.e., one which has similar business risk or risk relating to revenue uncertainty. This beta is then adjusted for differences in financial leverage to derive an estimate of beta for the company. Adjusting beta for financial leverage differences requires a process of \u201cunlevering\u201d and \u201clevering\u201d the beta.<\/p>\n\n\n\n<a href=\"https:\/\/analystprep.com\/free-trial\/\"\n   target=\"_blank\"\n   rel=\"noopener noreferrer\"\n   style=\"\n     display:block;\n     margin:20px 0 28px;\n     padding:14px 18px;\n     border:2px solid #2563eb;\n     border-radius:12px;\n     text-align:center;\n     color:#2563eb;\n     text-decoration:none;\n     font-weight:500;\n     font-size:15px;\n     background-color:#ffffff;\n   \">\n   Understand how to estimate beta using the pure-play method with a free trial.\n<\/a>\n\n\n<h2><strong>Steps in the Pure-play Method for Calculating Beta<\/strong><\/h2>\n<p><strong>Step 1:<\/strong> A comparable company is selected.<\/p>\n<p><strong>Step 2:<\/strong> The equity beta of the comparable company, <em>B<sub>L,comparable<\/sub><\/em> is estimated.<\/p>\n<p><strong>Step 3:<\/strong> The comparable company\u2019s beta is then unlevered by removing the effects of its financial leverage and leaving its business risk. The unlevered beta, <em>B<sub>U,comparable<\/sub><\/em>, is known as the asset beta.<\/p>\n<p>The equation to represent this is:<br \/>$$ { \\beta }_{ \\text{U,comparable} }=\\frac { \\beta _{ \\text{L,comparable} } }{ \\left[ 1+\\left( 1-{ t }_{ \\text{comparable} } \\right) \\frac { { D }_{ \\text{comparable} } }{ { E }_{ \\text{comparable} } } \\right] } $$<\/p>\n<p>Where:<\/p>\n<p><em>B<sub>U,comparable<\/sub><\/em>\u00a0= the asset beta for the comparable company<\/p>\n<p><em>B<sub>L,comparable\u00a0<\/sub><\/em>= the equity beta for the comparable company<\/p>\n<p><em>t<sub>comparable<\/sub><\/em> = the marginal tax rate<\/p>\n<p><em>D<sub>comparable<\/sub><\/em> = the debt of the comparable company<\/p>\n<p><em>E<sub>comparable<\/sub><\/em> = the equity of the comparable company<\/p>\n<p><strong>Step 4:<\/strong> The comparable company\u2019s asset beta is then adjusted or levered to arrive at an estimate of the equity beta for the company, <em>B<sub>L,company<\/sub><\/em>.<\/p>\n<p>The equation to represent this is:<\/p>\n<p>$$ \\beta _{ \\text{L,comparable} }={ \\beta }_{ \\text{U,comparable} }\\left[ 1+\\left( 1-{ t }_{ \\text{comparable} } \\right) \\frac { { D }_{ \\text{comparable} } }{ { E }_{ \\text{comparable} } } \\right] $$<\/p>\n<blockquote>\n<h2><strong>Question<\/strong><\/h2>\n<p>Company PQR is in the telemarketing business. The asset beta for a comparable company in the same industry is 1.3. If company PQR\u2019s debt-to-equity ratio is 1.2, and the corporate tax rate is 35%, what is company QPR\u2019s equity beta?<\/p>\n<ol style=\"list-style-type: upper-alpha;\">\n<li data-tadv-p=\"keep\">1.65<\/li>\n<li data-tadv-p=\"keep\">2.31<\/li>\n<li data-tadv-p=\"keep\">2.58<\/li>\n<\/ol>\n<p><strong>Solution<\/strong><\/p>\n<p>The correct answer is <strong>B<\/strong>.<\/p>\n<p>The comparable company\u2019s asset beta, <em>B<sub>U,comparable<\/sub><\/em>,\u00a0is given as 1.3. You are also provided with information which indicates that <em>t<sub>comparable<\/sub><\/em>= 35% and<\/p>\n<p>$$ \\frac { { D }_{ \\text{companyPQR} } }{ { E }_{ \\text{companyPQR} } } =1.2 $$<\/p>\n<p>Solving for <em>B<sub>L,company<\/sub><\/em> = 1.3 \u00d7 [1 + ((1-0.35) \u00d7 1.2)] = 1.3 \u00d7 (1 + 0.78) = 2.314.<\/p>\n<\/blockquote>\n<div class=\"notes_inv\">\n<hr \/>\n<p><em><a href=\"https:\/\/analystprep.com\/cfa-level-1-exam\/corporate-finance\/learning-sessions-curriculum-corporate-finance\/\">Corporate Finance &#8211; Learning Sessions<\/a><\/em><\/p>\n<\/div>\n\n\n<div style=\"text-align:center;margin:50px 0 30px;\">\n\n  <a href=\"https:\/\/analystprep.com\/free-trial\/\"\n     target=\"_blank\"\n     rel=\"noopener noreferrer\"\n     style=\"\n       display:inline-block;\n       padding:14px 34px;\n       background:linear-gradient(135deg,#4a74d1,#3b66c4);\n       color:#ffffff;\n       font-size:18px;\n       font-weight:600;\n       text-decoration:none;\n       border-radius:50px;\n       box-shadow:0 6px 18px rgba(59,102,196,0.25);\n     \">\n     Start Free Trial\n  <\/a>\n\n  <p style=\"\n       margin:18px auto 0;\n       max-width:620px;\n       font-size:16px;\n       line-height:1.6;\n       color:#333333;\n     \">\n     Build confidence in pure-play beta estimation and project cost of capital with CFA Level I exam-style practice questions.\n  <\/p>\n\n<\/div>\n","protected":false},"excerpt":{"rendered":"<p>When estimating the cost of equity using the Capital Asset Pricing Model (CAPM), a reliable estimate of beta must be used. The beta for a company that is not publicly traded may be estimated using the pure-play method. In the&#8230;<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[6],"tags":[],"class_list":["post-2670","post","type-post","status-publish","format-standard","hentry","category-corporate-finance","blog-post","no-post-thumbnail","animate"],"acf":[],"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v26.9 - https:\/\/yoast.com\/product\/yoast-seo-wordpress\/ -->\n<title>Beta and Project Cost of Capital | CFA Level 1<\/title>\n<meta name=\"description\" content=\"Estimating a project&#039;s cost of equity using CAPM requires a reliable beta. 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