Why Use Bottom-Up Betas?
Computing the cost of capital for a growth company, however, can be problematic. Changing product mixes, changing cost structures, rapidly changing capital structures, and increasing size are inherent qualities of growth firms. Furthermore, because growing companies typically do not pay dividends, using the constant dividend growth model to compute the cost of equity yields a cost of equity equal to the company’s growth rate. In light of this, there is a need to deal more explicitly with risk when establishing hurdle rates for growth companies. The abundance of information available on the Internet makes computing a risk-adjusted hurdle rate simple. Yet the literature to date has provided little to explain the computation of a risk-adjusted cost of capital using readily available information. The use of a bottom-up beta in computing the cost of equity component of the cost of capital is an exceptional method of capturing all types of risk. An example using Community Health Systems, Inc
