How do you typically adjust a company's high historical beta for cost of equity calculation?

In the context of calculating the cost of equity using the Capital Asset Pricing Model (CAPM), adjusting a company's high historical beta is a crucial step in ensuring that the beta reflects the firm's current risk profile rather than its past performance. Relevering the beta to match the updated capital structure accurately adjusts for the company's financial leverage.

When a company's capital structure changes—such as through new equity issuance or changes in debt levels—this can affect its risk profile and thus its beta. A higher debt ratio generally increases a company's beta because it amplifies the risk associated with equity returns; conversely, a lower debt ratio can decrease beta. Relevering the historical beta accounts for these changes in financial leverage by calculating an updated beta that reflects the proportion of debt and equity in the capital structure, ensuring it aligns with current market conditions and expectations.

This adjustment is key to providing an appropriate estimate of the cost of equity that is aligned with both the company's current operational realities and its risk profile as influenced by its capital financing structure.