Hundred Million Dollar Beta

Abstract

This case is about the practical and conceptual issues involved in estimating the beta of a company for the purpose of computing the cost of capital using the CAPM (Capital Asset Pricing Model). In many applications of the CAPM in the classroom, the beta is assumed to be known or is exogenously specified. This case is an opportunity to confront the fact that, in the real world the beta has to be estimated and there is often a wide range of uncertainity (confidence interval)around any point estimate of the beta. The issue that Delaware Chencery Court Vice Chancellor Judge Travis Laster needed to resolve in October 2014 was that the beta estimated by te plaintiff and the defendant varied so substantially that they implied a difference of over $100 million in the valuation of Rural-Metro. The case provides alive context to discuss conceptual and statistical issues that are often glossed over as minor details of the estimation process. In the real world, these apparantely minor details make a big difference to the results and can no longer be ignored. In an advanced course, the case also provides an opportunity to expose the participants to the large academic literature on beta estimation.