- Estimate thelevered beta for the firm(and each of its
businesses) using the unlevered beta from step 3 and the
leverage from step 4.
Clearly, this process rests on being able to identify the
unlevered betas of individual businesses.
Therearethreeadvantagesassociatedwithusingbottom-up
betas, and they are significant:
1.Wecanestimatebetasforfirmsthathavenopricehistory
sinceall we need isan identificationof the businessesin
which they operate. In other words, we can estimate
bottom-up betas for initial public offerings, private
businesses, and divisions of companies.
2.Sincethebetaforthebusinessisobtainedbyaveraging
across alarge numberof regressionbetas, itwillbe more
precisethanany individualfirm’s regressionbeta estimate.
The standarderror ofthe average beta estimate will be a
functionofthenumberofcomparablefirms usedinstep 2
and can be approximated:
Thus,thestandarderroroftheaverageofthebetasof 100
firms,eachofwhichhasastandarderrorof0.25,willbeonly
0.025: