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What Is Beta and How Is It Calculated?
What Is Beta and How Is It Calculated?
or….
Expected Return
If beta is a measure of risk, then investors
who hold stocks with higher betas should
expect a higher return for taking on that risk
E(R) = Rf + B(Rm-Rf)
where:
E(R) = Expected return
Rf = risk free rate of return
B = beta
Rm = market return
WACC
Weighted average cost of capital:
where:
D = market value of firm’s debt
Rd = return on debt securities
T = tax rate
E = market value of firm’s equity securities
Re = return on equity securities (from CAPM)
V = total value of firm’s securities (D + V)
WACC and Beta
WACC increases as the beta and the rate of
return on the equity securities increases (all
else constant)
WACC is used as the discount rate in DCF
models
Therefore, increasing WACC reduces the
firms valuation to reflect the increase in risk
How to Calculate Beta