The Daily Technical #91: Does a higher beta translate into a higher or lower valuation?

Good morning. Welcome to the 91st edition of The Daily Technical. You’re here for one reason so let’s dive in.

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OVERVIEW OF YESTERDAY’S QUESTION
How do you estimate the cost of debt?

To estimate the cost of debt, look at the yield on market-traded debt with similar risk.

If the company has no publicly traded debt, use a "synthetic rating." This involves assessing its credit rating and interest coverage ratio, then applying a default spread.

Common Mistakes

1. Forgetting to incorporate credit ratings. This is crucial when a company lacks publicly traded debt since it determines the default spread using a synthetic rating.

2. Omitting the interest coverage ratio. Ensure you calculate this ratio accurately by dividing EBIT by interest expenses, as it influences the default spread.

3. Using inappropriate debt yields. Use yields from debt with similar risk profiles. Align the risk profile specifically with the company's credit risk characteristics.

TL;DR

• Estimate cost of debt using yield on similar-risk market-traded debt.

• For non-traded debt, use a "synthetic rating" by assessing credit rating and interest coverage ratio.

• Apply default spread to determine cost for untraded company debt.

TODAY’S QUESTION
Does a higher beta translate into a higher or lower valuation?

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THAT’S A WRAP
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