Hi all, Just had a question on calculating unlevered beta when there is negative net debt. When I average my peer betas, I get a negative debt % and >100% equity weighting.
Can this really be correct or do I set a floor where max equity is 100%?
Any help would be greatly appreciated.
Thank you!
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I don’t know but it sounds like you are in the trenches. Good luck boss 🫡
This is mathematically correct, don’t set an artificial cap. This is not that uncommon
Thanks a lot for the answer!
It’s just the bot below suggests a cap, do you think it’s totally wrong? And do you work in PE?
When dealing with negative net debt, the situation arises because the company has more cash than debt. This can lead to unusual results in the calculation of unlevered beta, such as equity weighting exceeding 100% and debt weighting being negative. Here's how to approach this:
Negative Net Debt Impact: Negative net debt implies that the company is effectively less risky due to its cash reserves. This can result in a higher equity weighting (>100%) and a negative debt weighting in the unlevered beta formula.
Setting a Floor for Equity Weighting: It is not standard practice to arbitrarily cap equity weighting at 100%. The formula reflects the actual capital structure, and the negative debt weighting is a valid outcome in this scenario. Adjusting the formula to force equity weighting to 100% would distort the true risk profile.
Interpretation: Instead of modifying the formula, interpret the results in the context of the company's financial position. The negative debt weighting indicates that the company’s cash reserves reduce its overall risk, which is consistent with the concept of unlevered beta.
In summary, you should not set a floor for equity weighting at 100%. The formula is designed to reflect the actual capital structure, and the negative debt weighting is a natural outcome of having negative net debt.
Sources: DCF Modeling Course ~ Pre-training text.pdf, Notes for Technical Interview Questions, 21 Finance Interview Questions and Answers, Rough mental return calculations?
Just assume 0% leverage.
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