WACC vs Levered Beta

BBA18's picture
Rank: Senior Gorilla | banana points 750

I'm a RE Finance major who is applying to an honors finance program at my school. The program is primarily for placing kids into IB, which I'm not particularly interested in as a career path, but I want to learn the technical finance skills that IB guys have.

We're doing mock interviews for the program right now and one of I was asked a DCF question. When asked how to determine what discount rate to use I said that I would back out an asset beta from the company's equity beta (unless the investment was a scale-expansion) and plug it into the CAPM.

The interviewer said that this was wrong and that I should use WACC because it takes debt into account. My understanding is that using levered betas in the CAPM formula also takes debt into account because the asset beta formula is Beta_asset=Beta_equity(E/D(1-Tax)+E)). So isn't the capital structure taken into account?

Investment Banking Interview Course

  • 7,548 questions across 469 investment banks. Crowdsourced from over 500,000 members.
  • Technical, behavioral, networking, case videos, templates. All included.
  • Most comprehensive IB interview course in the world.

Comments (3)

Aug 21, 2017

Interviewer is right, in the beta you are acounting for the fact that equity becomes riskier with higher debt level, then in WACC you take into account the cost of debt and tax shields

Best Response
Aug 21, 2017
BBA18:

I'm a RE Finance major who is applying to an honors finance program at my school. The program is primarily for placing kids into IB, which I'm not particularly interested in as a career path, but I want to learn the technical finance skills that IB guys have.

We're doing mock interviews for the program right now and one of I was asked a DCF question. When asked how to determine what discount rate to use I said that I would back out an asset beta from the company's equity beta (unless the investment was a scale-expansion) and plug it into the CAPM.

The interviewer said that this was wrong and that I should use WACC because it takes debt into account. My understanding is that using levered betas in the CAPM formula also takes debt into account because the asset beta formula is Beta_asset=Beta_equity(E/D(1-Tax)+E)). So isn't the capital structure taken into account?

So you're taking seats from other kids to get into a program that is specialized for something you don't actually appreciate, and you don't know these basic answers? You seem kinda like a tool.

    • 4
Aug 21, 2017

I come from down in the Valley, where Mr. when you're young, they bring you up to do like your daddy done.

    • 1