A simple look at betas—and other inputs to the income approach

BVWireIssue #206-3
November 20, 2019

valuation methods & approaches
beta, cost of capital, discount rate, equity risk premium, income approach, normalization, management projections

When estimating a company’s cost of equity, we all know investors adjust for varying levels of risk. Whether you’re using the modified CAPM or the buildup method, significant differences in the proportional amount of financial leverage will have a significant impact on risk and therefore the cost of the equity. “We appraisers have relevering beta formulas at our disposal for this risk adjustment but understanding the formulas and their implementation can be challenging,” says Bob Dohmeyer (Dohmeyer Valuation Corp.). Challenging indeed! At a recent conference session that we attended, the audience had great difficulty grasping the notion of levering, unlevering—and then relevering—the cost of capital. Dohmeyer will be part of a panel that will take a fresh look at the income approach—from top to bottom—including the use of betas. “We’ll be discussing the simplest relevering beta formula and showing that it’s actually more simple and intuitive than it looks,” he says.

The panel will conduct a special four-hour online workshop November 21 titled Back to the Future? Exploding the Income Approach. The other panel members will be Bethany Hearn (CliftonLarsonAllen LLP), Brenda M. Clarke (Seigneur Gustafson LLP), and Kevin R. Yeanoplos (Brueggeman and Johnson Yeanoplos PC). The workshop will be divided into two parts: a discussion of current hot issues in the numerator (forecasting, free cash flow, and adjustments) and then an examination of the denominator (beta, equity risk premium, and company-specific risk). It will be part lecture and part debate, but totally relevant and practical.

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