asset betas, with the weights based on market value.
Consequently,thebetaforafirmisaweightedaverageofthe
betas of all the different businesses it is in. Thus, the
bottom-up beta for a firm can be estimated as follows.
1.Identifythebusinessorbusinessesthatmakeupthefirm
whosebetawearetryingtoestimate.Mostfirmsprovidea
breakdown of their revenues and operating income by
business in their annual reports and financial filings.
- Estimate the average unlevered betas of other publicly
traded firms that are primarily or only in each of these
businesses.Inmakingthisestimate,wehavetoconsiderthe
following estimation issues:- Comparable firms. In most businessesthere are at
leastafewcomparablefirms,andinsomebusinesses
there can be hundreds. We begin with a narrow
definitionofcomparable firms, andwiden itif the
number of comparable firms is too small. - Betaestimation.Oncealistofcomparablefirmshas
beenputtogether,weneedto estimatethebetasof
eachofthesefirms.Optimally,thebetaforeachfirm
willbe estimatedagainst a common index. If that
proves impractical, we can use betas estimated
against different indices. - Unleverfirst orlast.Wecancomputeanunlevered
betaforeachfirminthecomparablefirmlist,using
thedebt-to-equityratioandtaxrateforthatfirm,or
we can compute the average beta, debt-to-equity
ratio,andtaxrateforthesectorandunleverusingthe
averages.Giventhestandarderrorsoftheindividual
- Comparable firms. In most businessesthere are at