One more, i'm just curious, if we have incorporated all risk into the cashflow, should we use risk free rate as a discount rate OR use risk-adjusted discount risk which i think will double count the risk?
Stacey Warren - Expert brainly.com
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When you say that you have incorporated all the risk in the cash flow what precisely do you mean? If you simply probability weighted cash flows from different scenarios, then you need to discount that probability weighted cash flow by the risky discount rate (not the risk free rate). If you have probability weighted the cash flows AND adjusted the probability weighted cash flows to certainty equivalent cash flows, then you use the risk free rate as the discount rate.
Thanks valuator.. Can you help me to solve the Debt Beta? How to calculate it? Bd.. I want to test Wacc estimate with Debt Beta (assume its not Zero)
If the debt is publicly traded, estimate the debt beta in the normal fashion by regression bond returns against the market. Alternatively, you can infer the debt beta from the fair market yield on debt. Note that the capital asset pricing model is defined as follows:
Return on Security = Risk Free Rate + Beta*(Market Premium)
Solving for beta we discover
Beta = (Return on Security - Risk Free Rate)/Market Premium
The return on debt is its market yield. Therefore, the beta of debt can be estimated informally as follows:
Beta Debt = (Pre-tax Yield on Debt - Risk Free Rate)/Market Premium
By way of example, assume ABC Corporation has publicly traded debt with a fair market yield of 4%. The risk free rate is 3% and the market risk premium is 5%. Assuming the Capital Asset Pricing Model holds, the beta of the corporations debt can be computed as follows:
Beta Debt = (4% - 3%)/5% = 1%/5% = 0.20