Required Returnsadvanced

The Pure-Play Comparable Method

The pure-play method estimates a project’s discount rate from comparable firms whose entire business resembles the project, rather than from the diversified parent. The recipe is the same one used for divisional and private-firm betas. Find pure-play comparables, take each peer’s levered equity beta, unlever it to strip out that peer’s leverage, average the asset betas, then relever to the project’s own capital structure. The relevered beta feeds the CAPM to give a project cost of equity, which combines with an after-tax cost of debt into a project WACC.

Why it matters

A conglomerate’s own beta is a blend of everything it does, so it tells you little about one specific project. The trick is to look outside the firm for companies that do only the thing your project does, a pure play. Their market betas carry the project’s business risk directly. You cannot use a peer’s equity beta as is, because it also reflects that peer’s borrowing, so you unlever to reach the pure business risk, average across several peers to cancel noise, then re-dress that asset beta in your own project’s leverage. This peer procedure applies directly to the Catalina power project using listed power generators.

Formulas

Unlever each comparable to its asset beta

\beta_{U} = \dfrac{\beta_{e}}{1 + (1 - t)\,\frac{D}{E}}

Strip each pure-play peer’s leverage from its equity beta

\beta_{e}

to isolate the business-risk asset beta

\beta_{U}

. This standard Hamada form assumes a zero debt beta. With a positive debt beta, add the debt term as in the cost-of-capital cluster.

Relever the average asset beta to the project

\beta_{e}^{project} = \bar{\beta}_{U}\left[1 + (1 - t)\,\dfrac{D}{E}\right]_{project}

Average the peers’ asset betas to

\bar{\beta}_{U}

, then relever using the project’s own

D/E

. Feed the result into the CAPM to get the project cost of equity, then build the project WACC.

Worked examples

Scenario

A diversified parent wants the discount rate for a new power-generation project. Two listed pure-play generators have equity betas of 0.90 and 1.10 with debt-to-equity ratios of 0.60 and 1.00. The tax rate is 30 percent. The project will run at a debt-to-equity ratio of 0.50. Estimate the project’s relevered equity beta.

Solution

Unlever each peer in turn. For peer 1, $\beta_U = 0.90 / [1 + 0.70 \times 0.60] = 0.90 / 1.42 = 0.634$ . For peer 2, $\beta_U = 1.10 / [1 + 0.70 \times 1.00] = 1.10 / 1.70 = 0.647$ . The average asset beta is about 0.64. Now relever to the project’s $D/E$ of 0.50. The bracket is $\,1 + 0.70 \times 0.50 = 1.35$ , so the project’s equity beta is $\beta_e = 0.64 \times 1.35 = 0.86$ . That relevered beta, not the parent’s own beta, drives the project cost of equity.

Common mistakes

✗You can use the parent firm’s beta for the project. The parent’s beta blends every business it runs. The pure-play method goes outside to peers that match the project alone.
✗A peer’s equity beta can be relevered straight to the project. It still carries the peer’s leverage. You must unlever it to the asset beta before relevering to the project’s own structure.
✗One comparable is enough. Averaging several pure-play betas means that firm-specific noise in any single estimate washes out.
✗The pure-play method ignores capital structure. It removes the peers’ leverage and then re-applies the project’s leverage, so capital structure is handled carefully, not ignored.

Revision bullets

•Estimate the project rate from pure-play comparables, not the diversified parent
•Pure-play peers do only what the project does, so their betas carry its business risk
•Unlever each peer, average the asset betas, then relever to the project
•The relevered beta feeds the CAPM to give a project cost of equity
•Average several peers to cancel firm-specific noise
•This applies to the Catalina power project using listed generators

Quick check

The pure-play method estimates a project’s beta by starting from

In the pure-play procedure, why is each comparable’s equity beta unlevered before it is used?

Connected topics

Cost of Equity (CAPM)Levered Beta Debt Beta Divisional WACC Project Risk Rate

Sources

Titman & Martin, Ch. 5
Titman, S. & Martin, J. D. Valuation: The Art and Science of Corporate Investment Decisions. Pearson.
Chapter on estimating project required returns from comparable firms. The Catalina power-generation example uses the unlever, average and relever procedure on listed generators.
Fuller & Kerr (1981)
Fuller, R. J. & Kerr, H. S. "Estimating the Divisional Cost of Capital: An Analysis of the Pure-Play Technique." Journal of Finance, 36(5), 1981, pp. 997-1009.
Original statement and empirical test of the pure-play technique for estimating divisional and project costs of capital.

How to cite this page

Dr. Phil's Quant Lab. (2026). The Pure-Play Comparable Method. Derivatives Atlas. https://phucnguyenvan.com/concept/sabv-pure-play-method

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