Computing Debt Beta from Credit Spreads Rather than Assuming Zero Debt Beta

2. Beta on Debt Should be Derived from Bond Yields: The beta on debt is generally assumed away in considering the WACC. But the debt beta can be derived from the credit spread on debt given the EMRP and Rf. For example, the historic spread on BBB bonds is about 2% and the gearing of BBB companies is about 55%. This implies the beta on debt or Bd is given by the equation Cd = Rf + EMRP x Bd. Restating the equation implies that CSd = EMRP x Bd and Bd = CSd/EMRP. If the credit spread is 2% and the EMRP is 4%, the the Bd is .5. Data on the relationship between debt to capital and credit ratings can be used to derive the beta on debt as a function of the market capital structure

Total Interest Rate = Rf + Credit Spread

Total Interest Rate = Rf + EMRP * Debt Beta

Credit Spread = EMRP * Debt Beta

Debt Beta = Credit Spread/EMRP

Net Debt Percent = 1- Net Debt Percent