Question on levered beta calculation
Hi All--currently interview prepping, and have a quick question + would like confirmation I understand this correctly.
When calculating the cost of equity for WACC in a DCF, my understanding is that you should take the average levered beta of comparable firms, then re-lever based on the capital structure of the firm you are valuing. The formula to find unleveraged beta is below:
Unleveraged Beta = Avg. Leveraged Beta of Comps / (1+(1-Tax Rate)*(Debt/Equity Ratio))
Is the above debt/equity ratio calculated as the average debt/equity ratio for your comp set?
Once calculated, you re-lever using the following formula:
Leveraged Beta = Unleveraged Beta of Comps / (1+(1-Tax Rate)*(Desired Debt/Equity Ratio))
The resulting beta is what you use in the CAPM formula to get cost of equity. Is my description all correct?
Correction--I meant to say that the re-levering formula is Leveraged Beta = Unleveraged Beta of Comps * (1+(1-Tax Rate)*(Desired Debt/Equity Ratio))
It should be multiplied, not divided.
Close. Unlevered beta is the beta of the company’s operating assets, without the effect of leverage. Therefore, you want to take the average of the unlevered beta of the comp set (thereby getting a proxy for operating asset risk) then re-lever that beta at PF Capital structure (thereby getting a risk for the business that incorporates capital structure).
Gotcha. If you were looking at a comp set and calculating the beta in excel (covariance/variance formulas), that will give you the levered beta, correct? Therefore, wouldn't you have to take the average levered beta, unlever that average, then re-lever for your company?
normally you take the unlevered beta at average directly and re-lever
How do you calculate unlevered beta directly? I have only ever seen formulas where unlevered beta calculated based on levered beta.
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