Unlevering/Relevering betas

CFA Level I Portfolio Management
#1

Hi,

For a private company, and assuming my target capital structure is the industry’s average capital structure, why do I even unlever and relever the beta?

I get a sample of 10 comps, get the average levered beta of them, then unlever that beta at the average capital structure of them, then relever the beta at the average capital structure of them? It’s the same… I unlever at 50% and then relever at 50%… my levered beta is the same as the industry’s. Why would everybody say to unlever and then relever the beta?

Thanks

#2

You’re correct: if the capital structures are the same, then the betas will be the same.

Unlevering and relevering is done when you have a capital structure that differs from the company or industry whose beta you know.

#3

Thanks Bill. I wonder why Demodaran always says to unlever and relever the beta, even if my company is private and I assume my capital structure is the same as the industry’s. In the examples he gives on private companies, he either assumes the capital structure will be (i) the industry average, (ii) a optimal debt to equity ratio suggested by the management or (iii) the current market debt to equity ratio. When he does (i) he always unlevers and relevers the beta (and obviously gets the same comps’ levered beta), I don’t understand the point?

#4

Just one last question. In the calculation of WACC and then Enterprise Value, If I am to assume a different capital structure from the one my company currently has, then from Enterprise Value to Equity Value I can’t subtract the current debt, correct? I’ll have to figure out what the debt will be at that target capital structure and then subtract that value, am I right? To arrive at that debt value I would use the market value of equity and would calculate 2 equations with 2 unknowns:

Enterprise Value (let’s say $20m) - Debt (x) + Cash (let’s say $1m) = Equity Value (y)

Debt (x) / Equity Value (y) = Target Capital Structure assumed in the WACC (let’s say 40%)

Am I correct?

Thanks!

#5

No, I believe you would still subtract the company’s actual debt. The $ amount of debt in an optional capital structure is kind of like the notional principal in an interest rate swap - use it to figure out the interest expense needed to compute FCF at a rate consistent with the WACC.

#6

One question regarding unlevered betas since I wasn’t able to find it. What would be the effect on a unlevered beta if the TAX Rate increases? According to the formula it should change but not quite confident…