- Weighted Average Cost of Capital (WACC)
- Methods of Calculating Weights in WACC
- Applications of Cost of Capital
- Weighted Average Cost of Capital (WACC) - Practical Example and Issues
- Calculating Cost of Debt: YTM and Debt-Rating Approach
- Issues in Estimating Cost of Debt
- Estimating the Cost of Preferred Stock
- Estimating the Cost of Common Stock
- Calculating Beta Using Market Model Regression (Slope)
- Calculating Beta Using Pure Play Method
- Estimating the Country Risk (Country Equity Premium)
- Marginal Cost of Capital (MCC) Schedule
- Flotation Costs and WACC

# Calculating Beta Using Market Model Regression (Slope)

While calculating the cost of equity, it is important for an analyst to calculate the beta of the company’s stock.

Beta of a publicly traded company can be calculated using the **Market Model Regression (Slope).**

In this method, we regress the company’s stock returns (ri) against the market’s returns (rm). The beta (β) is represented by the slope of the regression line.

$r_{i}=\alpha +\beta r_{m}$

Where,

r_{i} is the stock’s return

α represents the intercept

β is the stock’s beta

r_{m} is the market returns

See this article – **How to Calculate Stock Beta Using Excel**

Some of the issues while calculating beta are discussed below:

**Estimation period:**Beta is usually estimated using the historical data for 2-9 years. The choice of estimation period affects the calculation of Beta. If the estimation period is short, it does reflect the current dynamics of the company. For example, for a company that has recently undergone structural changes, it’s better to use short estimation period for calculating beta. However, for a company that has a stable operating history, a long estimation period will be suitable.**Return interval:**An analyst may take daily, weekly, or monthly returns of the stock and market while performing regression. Generally a shorter observation period such as daily returns leads to lower standard error.**Choice of the market index:**The analyst also needs to carefully choose a market index to regress the returns against.**Smoothing techniques:**Betas also have a tendency to revert to 1. Analysts may have to use some smoothing techniques to adjust the beta.**Small-cap stocks**: The small cap stocks tend to be more risk with a higher return potential. Therefore, analysts may want to adjust the beta pf small cap stock upwards.

Using the above methods, we can easily estimate the beta of a publicly traded company, as all the information such as historical returns is publicly available. The problem arises when an analyst is required to estimate the beta of a non-public company or a project, for which there is no historical stock return data. The analyst may have to use a proxy of the beta by using some combination of the information available about the company/project and a comparable public limited company. A commonly used method is the **pure-play method**, in which an analyst observes the beta of a comparable public company, and adjusts it for the difference in financial leverage.