Unlevering a Beta

Unlevering a Beta

In the time of action of calculating a weighted average cost of capital for a discounted cash flow examination, one must often unlever a Beta. Lets take a look at the time of action.

Calculating Beta is the fun part of the capital asset pricing form (CAPM). Since Beta is a measure of how a stock moves with the overall market, you would calculate it by doing a regression examination of the stocks performance against a general index such as the S&P 500. Fortunately, many stock information sets such as Bloomberg or Yahoo Finance have already calculated this value for stocks.

The problem with these Betas is that they are levered. We need an unlevered value for our cost of equity calculation. The reason we need this unlevered value is that the amount of debt or leverage that a company has can affect its Beta. And since a possible acquirer of a company could choose to considerably alter its capital structure, we should take out the effect of leverage to have a better sense of the companys value.

Unlevering a Beta

Unlevering a Beta can be a tricky course of action. The formula for an unlevered Beta is as follows:

Unlevered Beta = Equity Beta / [ 1 + (1 – tax rate) * Debt / Equity]

The equity Beta would be the Beta you get from Yahoo Finance on the meaningful Statistics page. You can calculate the companys tax rate by dividing tax expenses by before tax income on the companys income statement. Debt is the companys total debt. Equity in this case is the market value of the companys equity – its market capitalization.

Beta Comps

As if calculating an unlevered Beta were not tricky enough, you cant calculate a Beta for private companies. Instead, we must analyze industry comparables to find an average or median unlevered Beta as an approximation for our companys Beta.

What this method is that we need to look up public comps for our company, calculate each of their unlevered Betas and take an average. We can now use this average Beta in our capital asset pricing form and in calculating weighted-average cost of capital.

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