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Subject 5. Estimating the Cost of Equity for Private Companies PDF Download

Estimate Beta for a Private Firm

Most models of risk and return use past prices of an asset to estimate its risk parameters (beta(s)). Private firms, however, are not traded and thus do not have past prices. The beta for a private firm can be estimated by looking at the average betas for publicly traded companies in the same industry. Any differences in financial leverage can be adjusted for in the final estimate.

  • Estimate the average beta for the public traded comparable firms. This is the benchmark beta (levered): βe.
  • Estimate the average market value debt-equity ratio of these firms, and calculate the unlevered beta for the business: βu = βe/ (1 + D/E).
  • Estimate the debt-equity ratio for the private firm: D'/E'.
  • βprivate firm = βu (1 + D'/E')

Illiquidity is another risk factor associated with private companies.

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