medium · Principles of Finance cost-of-capital-structure
An analyst finds that all pure-play competitors for a new division have much higher D/E ratios than the parent company intends for the new division.
What is the standard procedure to handle this?
- Exclude these high-leverage competitors from the sample entirely and simply use the parent company's own beta instead.
- Unlever the competitors' betas using their high D/E ratios, then relever the average using the division's lower target D/E.
- Use the competitors' levered betas directly as reported, without any adjustment, in order to remain appropriately conservative.
- Adjust the division's target D/E ratio to match the competitors' higher leverage levels in order to ensure comparability across the sample.
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