1
Estimating the Hurdle Rate
Estimating the Hurdle Rate
2
Hurdle Rate
Investment Decision specifies that a firm should invest in
assets only if they expect them to earn more than the hurdle
rate.
What should be this Hurdle rate?
o Suppose you borrow all funds required to fund a project,
paying 12% pa interest on the funds borrowed.
o The project should earn at least 12% so as to be profitable.
Cost of Capital represents the minimum return that a firm
needs to earn on its projects.
It is the compensation for time and risk in the use of capital by
a project.
How is it estimated?
As a firm raises funds from different sources, so the weighted
average of the individual costs is the cost of capital (the
hurdle rate)
26Nov13
2
Estimating the Hurdle Rate
3
Cost of Debt
Discount rate which equates the present value of interest
payments and principal repayments with the net proceeds of the
debt issued or its current market price.
n
t n
0 t n
t=1
d d
C F
P= +
(1+k ) (1+k )
3 1 2 n n
0 1 2 3 n n
d d d d d
C C C C F
P = + + +........+ +
(1+k ) (1+k ) (1+k ) (1+k ) (1+k )
where,
P
0
= net amount realised on debt issue (or CMP)
C
t
= Periodic interest on Debentures
F
n
= Face Value/ Redemption price
n = Maturity period
K
d
= Cost of debt
Estimating the Hurdle Rate 4
Cost of Debt  Illustration
F
n
=100/ ; C= 14/ ; n = 5 Years; P
0
= 97/
5
t 5
t=1
d d
14 100
97= +
(1+k ) (1+k )
n 0
d
0 n
(F P )
C+
n
k
(P +F )
2
where,
P
0
= net amount realised on issue of Preference share /CMP
PD
t
= Dividend on Preference Shares
F
n
= Redemption Value
n = Maturity period of Preference Shares
k
p
= Cost of Preference Capital
3 1 2 n n
0 1 2 3 n n
p p p p p
PD PD PD PD F
P = + + +........+ +
(1+k ) (1+k ) (1+k ) (1+k ) (1+k )
n 0
t
p
0 n
(F P )
PD +
n
k
(P +F )
2
An approximation:
26Nov13
5
Estimating the Hurdle Rate
9
Cost of Preference CapitalIllustration
ABC Ltd. issues Rs.1,000/ face value preference shares carrying 12%
dividend, redeemable at par after 3 years. Net amount realised today
is Rs.960/. Tax Rate= 40% . What is the cost of Preference Capital?
t
0 t
t=1
p
PD
P =
(1+k )
t
p
0
PD
k =
P
or
Irredeemable (Perpetual) Preference Shares
p
(1000960)
120+
133.33
3
k = =13.6054%
(1000+960)
980
2
3
t 3
t=1
p p
120 1000
960= +
(1+k ) (1+k )
By trial & error: k
p
= 13.7147% or
F
n
= 1000 ; PD
t
= 120 ; n =3 years; P
0
= 960
Estimating the Hurdle Rate
10
Cost of Equity
There is no legal obligation to pay dividends to the shareholders
Quantum of dividends is also not fixed.
Cost of Equity shares is an Implicit cost.(not explicit)
It is an Opportunity Cost. (Returns forgone on the next best
investment opportunity of comparable risk)
Methods of computing Cost of Equity Capital:
Dividend Discount Model (DDM)
Capital Asset Pricing Model (CAPM)
26Nov13
6
Estimating the Hurdle Rate
11
Cost of Equity Capital: Dividend Discount Model (DDM)
Discount rate that equates the present value of the stream of
expected future dividends with the current market price/Issue
Price.
3 1 2
0 1 2 3
e e e e
D D D D
P = + + +..........+
(1+k ) (1+k ) (1+k ) (1+k )
t
0 t
t=1
e
D
P =
(1+k )
D
t
= Expected Dividend per share at time t
k
e
= Cost of Equity
Estimating the Hurdle Rate 12
DDM  Constant Growth
If the dividends are expected to grow at a constant rate g, and k
e
> g, then,
Assumptions:
D
1
> 0
Dividends grow at a constant growth rate g =ROE*b
Dividend Payout ratio (1b) is constant
1 2 3
1 1 1 1
0 1 2 3 4
e e e e
D D (1+g) D (1+g) D (1+g)
P = + + + +..........+
(1+k ) (1+k ) (1+k ) (1+k )
1
0
e
D
P =
(k  g)
1
e
0
D
k = +g
P
Or
26Nov13
7
Estimating the Hurdle Rate
13
DDM  Constant Growth
TrueValue Ltd intends to pay a dividend of Rs. 5/ next year, and
expects the dividends to grow @ 6% each year till perpetuity. The
Companys market price currently is Rs. 50/. What of the cost of
Equity shares?
TrueValue Ltd intends to pay a dividend of Rs. 5/ next year, and
expects the dividends to grow @ 6% each year till perpetuity. The
Companys market price currently is Rs. 50/. What of the cost of
Equity shares?
D
1
= Rs.5/ ; g= 6% forever, P
0
= Rs.50/. Find k
e.
k
e
= (5 / 50) + 6%
= 10%+ 6% = 16%.
Mostly used for companies in the mature stage of their life cycle
1
e
0
D
k = + g
P
Estimating the Hurdle Rate
14
How to estimate Growth Rate?
1. Historical Growth Rates: If earnings and dividends growth
rates have been relatively stable in the past, and investors
expect these trends to continue in the future, then the past
realised growth rates may be used to estimate the expected
future growth rates.
2. Retention Growth Model: Firms pay some part of their net
income as dividends and retain the balance.
Growth rate of a firm will be depended on the net income
retained by it and the rate it earns on the retentions., Thus
g = ROE*Retention ratio, where Retention ratio = 1 Payout ratio
3. Analysts forecasts: Security analysts provide forecasts on
regular basis, using nonconstant growth.
26Nov13
8
Estimating the Hurdle Rate 15
DDM  Multiple Growth Rate
n
t1 t n n+1
0 n t n
t=1
e e e n
D (1+g ) P D
P = + where P =
(1+k ) (1+k ) k  g
n
t1 t n+1
0 t n
t=1
e e e n
D (1+g ) D 1
P = +
(1+k ) (1+k ) k  g
`
)
` `
) )
P
0
= 125 ; D
0
= 3.50; g
13
=15% g
46
=12% g
7+
=8%
26Nov13
9
Estimating the Hurdle Rate
17
Cost of Equity Capital: BondYield plus Risk Premium
k
e
: Bond Yield on Cos longterm debt + Bond risk premium (35%)
Bonds of NCE Ltd has a yield of 11% and the bond risk premium is
estimated at 3.8%, then the estimated cost of equity is 14.8% (11% +
3.8%)
Estimating the Hurdle Rate 18
Cost of Equity Capital: Capital Asset Pricing Model (CAPM)
Expected rate of return on any security R
i
is given by:
i f
R =R + Equity Risk Premium
where,
R
i
= Rate of return on security i
R
f
= Riskfree rate of return
R
m
= Rate of return on Market Portfolio
i
= beta of security i
R
m
 R
f
= Market Risk Premium
R
f
=10%; R
m
=15%;
A
= 0.5;
B
=1.0;
C
= 1.5; Find R
i
R
A
=10% + 0.5(15%10%) = 12.5%
R
B
=10% + 1.0(15%10%) = 15.0%
R
C
=10% + 1.5(15%10%) = 17.5%
i f i m f
R =R + (R  R )
26Nov13
10
Estimating the Hurdle Rate 19
External and Internal Equity
Equity External equity (additional /Outside) and Internal
equity(Retained Earnings)
In both cases, the shareholders are providing the funds to the
firm, hence they would expect same returns on both.
But, Internal Equity is cheaper than External Equity due to:
New equity is issued at less than the Current Market Price;
Issue of new Equity involves Floatation Costs.
As External Equity is expensive than Internal Equity, an
adjustment has to be made.
1
re
0
D
Internal Equity k = +g
P
1
e
0
D
External Equity k = +g
I
CMP = Rs 100/ ; I
0
= Rs 95/ ; D
1
= Rs 5/ ; g = 6%
re
5
k = +6%=11%
100
e
5
k = +6%=5.26%+6%=11.26%
95
Estimating the Hurdle Rate 20
Weighted Average Cost of Capital
After having calculated the cost of individual components of the
capital structure, we need to calculate the Weighted Average
Cost of Capital (WACC).
Weights MAY be either:
(a) Market Value of the various forms of financing, which the company
intends to employConsistent with the objective of maximization of
shareholders wealth
(b) Book Value of the Capital Structure.
WACC should be estimated on posttax basis.
0 e d
E D
WACC(k )=k +k (1t)
(D+E) (D+E)
26Nov13
11
Estimating the Hurdle Rate
21
Marginal Cost of Capital
WACC is calculated based on the various sources of capital
already employed by the firm.
Such WACC provides a historical perspective can at best be
used to compare with some predetermined cost of capital.
However, the most important use of the concept of Cost of
Capital is to evaluate Investment decisions.
Therefore, more relevant cost to be worked out should be cost
of raising new funds to finance new projects and not the
historical costs which have been incurred in the past.
Therefore, weighted average cost of capital should be calculate
for the incremental or marginal capital Weighted Marginal
Cost of Capital (WMCC).
Risk & Return
26Nov13
12
Stock Returns
Stock Returns = (845  625) /625 = 35.20%
Total Stock Returns = (845625+25) /625= 39.20%
23
Stock returns are considered instead of stock prices.
Stock Returns = (P
t
 P
t1
) /P
t1
Log Returns = ln(P
t
/P
t1
)
Total Stock Returns = (P
t
 P
t1
+D
t
) /P
t1
Estimating the Hurdle Rate
The price of Reliance share is Rs. 845/ today and was Rs 625/ one
year ago. It paid a dividend of Rs. 25/ per share. What is the return
over the oneyear period?
Stock returns over the years
24
40%
20%
0%
20%
40%
60%
80%
1
9
9
1

9
2
1
9
9
2

9
3
1
9
9
3

9
4
1
9
9
4

9
5
1
9
9
5

9
6
1
9
9
6

9
7
1
9
9
7

9
8
1
9
9
8

9
9
1
9
9
9

0
0
2
0
0
0

0
1
2
0
0
1

0
2
2
0
0
2

0
3
2
0
0
3

0
4
2
0
0
4

0
5
2
0
0
5

0
6
2
0
0
6

0
7
2
0
0
7

0
8
2
0
0
8

0
9
2
0
0
9

1
0
2
0
1
0

1
1
2
0
1
1

1
2
Stock returns are high but are volatile also.
Estimating the Hurdle Rate
Instrument Nominal Real Average Risk Premium
(over 1year GOI)
1 year GSec yield
9.29 1.71 0.00
Corporate Bonds
(AAA rated)
13.50 6.35 4.21
Equity Shares
22.89 15.98 13.61
Average Rates of Return (1978 2011)
% per year
26Nov13
13
Stock Returns
Expected Stock Returns = (0.30*16%) + (0.50*11%) + (0.20*6%)
= 11.50%
25
Expected Stock returns : E(R
i
) = p
i
*R
i
Estimating the Hurdle Rate
State of Economy Probability of
Occurrence
Rate of Return
(%)
Boom 0.30 16
Normal 0.50 11
Recession 0.20 6
Portfolio returns is the weighted average of the
individual stock returns.
where,
x
1
, x
2
: %age of funds invested in stock 1,2.
r
1
, r
2
: %age return of stock 1,2.
Portfolio Returns
26
1 1 2 2
Portfolio Returns = x r + x r
Estimating the Hurdle Rate
Expected returns on security A is 16 % and on security B is
14 per cent and an investor wants to create a portfolio of
two asset with equal weightage. What would be the
expected portfolio returns?
E(Portfolio AB) =(0.5 x 14%) + (0.5 x 16%) = 15%
26Nov13
14
Risk
Risk is the possibility of adverse outcome.
In finance, risk is defined as the likelihood of outcome being
different from expected outcome.
Actual outcome may be better or worse than expected.
1. Company Specific: Risks which are unique to a company.
Law suits, strikes, Successful /Unsuccessful projects etc.
Impact of such factors can be minimized, hence are called
Diversifiable risks.
2. Market Risks are caused by factors which systematically
affect all or most firms.
War, Inflation, Change in Govt. Policies. Interest Rates etc.
Such risks cannot be eliminated, hence called Non
diversifiable risk
Originates from the system, hence called Systematic Risk.
Statistical measure of risk is Standard Deviation (or Variance )
27 Estimating the Hurdle Rate
Portfolio Risk
28 Estimating the Hurdle Rate
Year
Stock A Stock B
Portfolio AB
(50%) (50%)
2008 40% 10% 15%
2009 10% 40% 15%
2010 35% 5% 15%
2011 5% 35% 15%
2012 15% 15% 15%
Average 15% 15% 15%
Standard Deviation 22.64% 22.64% 0.00%
26Nov13
15
Portfolio Risk
29 Estimating the Hurdle Rate
20%
10%
0%
10%
20%
30%
40%
50%
2008 2009 2010 2011 2012
Stock A
20%
10%
0%
10%
20%
30%
40%
50%
2008 2009 2010 2011 2012
Stock B
20%
10%
0%
10%
20%
30%
40%
50%
2008 2009 2010 2011 2012
Portfolio AB
20%
10%
0%
10%
20%
30%
40%
50%
2008 2009 2010 2011 2012
20%
10%
0%
10%
20%
30%
40%
50%
2008 2009 2010 2011 2012
20%
10%
0%
10%
20%
30%
40%
50%
2008 2009 2010 2011 2012
When stocks are
When stocks are
Portfolio Risk
30
S
t
o
c
k
1
S
t
o
c
k
2
2 2
1 1
x
2 2
2 2
x
1 2 12
x x
1 2 12 1 2
x x =
1 2 12
x x
1 2 12 1 2
x x =
Stock 1 Stock 2
2 2 2 2
1 1 2 2 1 2 12 1 2
Portfolio Variance = x + x + 2(x x )
where,
x
1
, x
2
: %age of funds invested in stock 1,2.
1
,
2
: standard deviation return of stock 1,2
12
: coefficient of correlation between stock 1 & 2.
Estimating the Hurdle Rate
26Nov13
16
Risk (Standard Deviation) selected stocks
31
Stock Standard Deviation
Hindustan Unilever 28.60%
Hero Honda 28.80%
Infosys 29.20%
NTPC 30.00%
Bharati Airtel 33.50%
ONGC 37.30%
L&T 46.90%
Tata Motors 54.80%
Sterlite Industries 59.60%
Tata Steel 62.30%
Estimating the Hurdle Rate
Portfolio Risks & Returns
32
Hero Honda Tata Steel
Stock Returns 16% 24%
Stock Standard Deviation 29% 62%
Weights 50% 50%
Portfolio Returns: 20.00%
Portfolio Standard Deviation:
Case 1: = + 1 45.50%
Case 2: = 0 34.22%
Case 3: =  1 16.50%
Estimating the Hurdle Rate
26Nov13
17
10%
15%
20%
25%
30%
1 4 7 10 13 16 19 22 25
No. of Securities
Reducing Risk
33
S
t
a
n
d
a
r
d
D
e
v
i
a
t
i
o
n
Market Risk
Estimating the Hurdle Rate
By combining stocks, the Company specific risks get eliminated (hence Diversifiable
Risks), while the Market risk still remains (hence Nondiversifiable Risks).
Company Specific Risks
Risk (Standard Deviation & Beta) selected stocks
34
Stock Standard Deviation Beta ( )
Hindustan Unilever 28.60% 0.41
Hero Honda 28.80% 0.57
Infosys 29.20% 0.55
NTPC 30.00% 0.72
Bharati Airtel 33.50% 0.76
ONGC 37.30% 0.95
L&T 46.90% 1.38
Tata Motors 54.80% 1.48
Sterlite Industries 59.60% 1.66
Tata Steel 62.30% 1.77
Stocks with high standard deviation also have high beta
Estimating the Hurdle Rate
26Nov13
18
RiskReturn relationship of various securities
Risk (%)
R
e
t
u
r
n
s
(
%
)
Equity Shares
Preference Shares
Corporate Bonds
Government Bonds
Riskfree securities
Estimating the Hurdle Rate 35
SML
Beta and its Estimation
26Nov13
19
Estimating Beta
Beta of a security measures the Market (Non
diversifiable or Systematic) risk.
Methods of estimating beta:
Regression method
Bottomup Beta
Accounting Beta
37 Estimating the Hurdle Rate
#1 Regression Method
38
Year R
a
R
m
1 12 10
2 14 12
3 16 13
4 12 8
5 5 3
6 21 14
7 20 14
8 16 8
9 9 4
10 2 1
11 13 10
12 15 16
13 19 12
14 15 10
15 20 17
10
5
0
5
10
15
20
25
5 0 5 10 15 20
S
t
o
c
k
R
e
t
u
r
n
(
R
a
)
Market Return (R
m
)
Estimating the Hurdle Rate
26Nov13
20
Estimating Beta Regression Method
Coefficients
Standard
Error t Stat Pvalue
Lower
95%
Upper
95%
Intercept 0.075 2.317 0.032 0.975 5.080 4.930
Rm 1.307 0.209 6.264 0.000 0.857 1.758
Regression Statistics
R Square 0.751
Adjusted R Square 0.732
Observations 15
a m
R = 0.075+1.307 R
75% of the risk is
due to Market
39
Estimating the Hurdle Rate
Regression Statistic
Coefficient of Determination (R
2
) :
Goodness of Fit indicates the %age of risk attributed to
Market risk.
R
2
= 0.751 or 75% of change in stock returns are due to
changes in market returns,
(1R
2
) or 25% is caused by firm specific reasons.
Standard Error (s
e
):
Indicates the error in estimate between estimated Beta and
true beta
S
e
=0.209: true beta lies between 1.037 1(0.209) with 67%
confidence.
40 Estimating the Hurdle Rate
26Nov13
21
Direct Method
41
Year R
a
R
m
R
a
AvgR
a
R
m
AvgR
m
(R
a
avg R
a
)x
(R
m
AvgR
m
)
(R
m
AvgR
m
)
2
1 12 10 1 0 0 0
2 14 12 1 2 2 4
3 16 13 3 3 9 9
4 12 8 1 2 2 4
5 5 3 18 7 126 49
6 21 14 8 4 32 16
7 20 14 7 4 28 16
8 16 8 3 2 6 4
9 9 4 4 6 24 36
10 2 1 15 11 165 121
11 13 10 0 0 0 0
12 15 16 2 6 12 36
13 19 12 6 2 12 4
14 15 10 2 0 0 0
15 20 17 7 7 49 49 Estimating the Hurdle Rate
Beta estimation
42
n
a a m m
(a,m)
1
(R  Avg R )(R  Avg R ) 455
Covariance = = = 32.50
(n1) 14
2
n
m m
(m)
1
(R  Avg R ) 348
Variance = = =24.86
(n1) 14
(a,m)
a
(m)
Covariance
32.50
(Beta)= = = 1.3075
Variance 24.86
Estimating the Hurdle Rate
26Nov13
22
Comparing Returns
By regressing stock returns on Market returns, we get
Further, using CAPM, we have
In terms of excess returns:
(Regress excess returns on security on excess returns on market)
In terms of raw returns:
(Regress raw returns on security on raw returns on market)
In both regressions, slope of the regression is the beta of the
security.
Intercept is measure of stock performance relative to the market:
In excess returns regression:
if intercept is 0, the stock performed as per market.
if intercept is +ve (ve), stock performed better (worse) than the market.
43
j f j m f
R =R + (R  R )
j j m
R =+ R
j f j j m
R =R (1 )+ R
Estimating the Hurdle Rate
j f j m f
R  R = (R  R )
Comparing Returns
In raw returns regression: the intercept has to be compared with
predicted intercept .
If , stock performed better than expected
If , stock performed worse than expected
Measure of stock performance in case of excess returns
regression and in case of raw returns regression is
called Jensens Alpha.
44
f
> R (1)
f
< R (1)
f
 R (1)
Estimating the Hurdle Rate
f
R (1)
26Nov13
23
Issues in estimating Beta
Length of estimation period:
Longer period provides more data points but firms
might change in its risk profile over longer period.
Most estimates of beta use 5 year data
Return Interval:
Daily /Intra day interval increases data points but
increases nontrading bias
Monthly/Weekly interval reduces nontrading bias.
Choice of Market Index:
Most estimates use stock market index
Should be a broad based index
45
Estimating the Hurdle Rate
Riskfree rate of return (R
f
)
Return on a riskless asset is the riskfree rate.
Riskless asset should be:
Default free security i.e. should be issued by Government.
No uncertainty of reinvestment i.e. there are no cash flows
prior to the end of horizon period. Zero Coupon securities.
Tenure of GSecurities:
Depends upon the cash Flows being analyzed.
If CFs are 5yr CFs, we need 5 yr rate.
Riskfree rate is the rate of return on Zerocoupon Govt.
Securities that matches the time horizon of the cash flows being
analyzed.
46
Estimating the Hurdle Rate
26Nov13
24
Factors affecting Beta
1. Type of Business:
More sensitive the business is to market conditions,
higher would be the Beta of the security.
Cyclical firms higher beta
Food processing/tobacco firms are less sensitive to
market conditions.
If product purchase is discretionary, such firms would
have higher beta (P&G/HUL vs. Designer Wear)
47 Estimating the Hurdle Rate
Factors affecting Beta
%age change in OperatingProfit
DOL=
%age change in Sales
EBIT
*100
EBIT
DOL=
Sales
*100
Sales
48
2. Degree of Operating Leverage:
Firms with high DOL will also have high variability in operating
profits, hence higher Beta.
Estimating the Hurdle Rate
26Nov13
25
Factors affecting Beta
3.Degree of Financial Leverage:
As Financial Leverage increases, Beta also increases.
49
%age change in EPS
DFL=
%age change in Operating Profit
EPS
*100
EPS
DFL=
EBIT
*100
EBIT
Estimating the Hurdle Rate
Levered and Unlevered Beta
50
Assets of a levered firm are financed by debt & equity.
Asset beta should be weighted average of equity beta & debt beta.
For an allequity financed firm (Unlevered), the asset beta and
equity beta would be same.
Asset or Unlevered Equity Debt
E D
= +
D+E D+E
   
 
\ \
Estimating the Hurdle Rate
26Nov13
26
Levered and Unlevered Beta
51
For a levered firm, if we assume that beta of Debt is zero, then
asset beta would be:
As leverage increases, equity beta also increases.
If we consider the tax deductibility of debt, equity beta of a
levered firm, would be:
(developed by Hamada,1972)
Equity Asset or Unlevered
D
= 1+(1t)
E
(
 
 (
\
Asset or Unlevered Equity
E
=
D+E
 

\
Equity Asset
D
= 1+
E
 

\
Estimating the Hurdle Rate
# 2 Bottomup Beta
What if historical stock prices are not available?
Steps:
1. Identify the businesses in which the firm operates(pureplay
firms)
2. Estimate the unlevered betas of these pureplay publicly
traded firms in each businesses.
3. Take the weighted average of the unlevered betas, using
proportion of firm value in each business as the weights.
4. Use current value of debt & equity of the firm, to compute
the levered beta.
52 Estimating the Hurdle Rate
26Nov13
27
Bottomup Beta
53
Find the beta of Co. X with Equity of Rs 517 million and Debt of
Rs. 113 million. Betas of comparable firms are as follows:
(tax rate = 35%)
Estimating the Hurdle Rate
Company Beta Equity Debt
A 0.60 250 150
B 1.25 16 26
C 0.95 612 152
D 0.75 187 158
E 0.55 32 9
Bottomup Beta
54
( ) (
0.82
= = 0.63405
1+(10.35) 0.4512
Average Levered Beta = 0.82
Average D/E = 495/1097 = 0.4512
Unlevered Beta =
(  
 (
\
Equity
D
1+(1t)
E
(  
 (
\
U
D
= 1+(1t)
E
113
= 0.63405 1+(10.35) =0.72413
517
(  
 (
\
Estimating the Hurdle Rate
Company Beta Equity Debt
A 0.60 250 150
B 1.25 16 26
C 0.95 612 152
D 0.75 187 158
E 0.55 32 9
Average 0.82 1,097 495
Levered beta of Co. X
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28
Levered and Unlevered Beta
55
Company Y has an Equity Beta of 0.80 when the firm had D/E of 0.2:1
(t=30%). The company intends to increase the D/E to 1:1. What would
be the beta at D/E of 1:1. (Assume Debt has tax advantage).
Given: at D/E of 0.2:1 and t = 30%
To estimate:
Unlevered Beta:
Equity (Levered) Beta at D/E of 1:1
Equity
= 0.80
U
0.80
= =0.7018
0.20
1+(10.30)
1
(
 

(
\
E
1
=0.7018 1+(10.30) =1.1931
1
(
 
 (
\
Equity
at D/E of 1:1
Estimating the Hurdle Rate
# 3 Accounting Beta
Instead of regressing stock returns on index returns, if we use the
accounting earnings > accounting beta.
Pitfalls:
Accounting earnings are relatively smoothen.
(betas are likely to be closer to one)
Likely to be influenced by accounting policies depreciation
method, allocation of expenses etc.
56 Estimating the Hurdle Rate
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29
Beta of select companies
57
Company Beta R
2
ABB 0.89 0.53
ACC 0.70 0.38
BHEL 1.02 0.59
ITC 0.53 0.36
Reliance Infrastructure 1.79 0.74
SBI 1.10 0.64
Suzlon 1.55 0.49
Unitech 1.68 0.42
Tata Steel 1.44 0.62
Estimating the Hurdle Rate
Portfolio Beta
58 Estimating the Hurdle Rate
Beta of a portfolio of securities is the weighted average of its
individual securities betas.
Portfolio
=
1
*w
1
+
2
*w
2
+
3
*w
3
+ .+
n
*w
n
Company Beta Weights Beta * W
ABB 0.89 0.30 0.267
ACC 0.70 0.15 0.105
BHEL 1.02 0.45 0.459
ITC 0.53 0.10 0.053
Portfolio Beta 0.884