Unlevered beta is the beta coefficient of a company under the assumption that it has no debt. It is synonymous to asset beta.
Unlevered beta is an intermediate input in the pure play method. In order to estimate equity beta for a non-public company, say Company A, equity beta of a similar publically-traded company, say Company B, is unlevered and then (that unlevered beta is) relevered in accordance with capital structure of Company A.
|Unlevered Beta =||Equity Beta|
|1 +||Debt||× (1 − Tax Rate)|
Hidayat Shah works as a financial analyst at Agha Investments. His next assignment is valuation of Bolan Electric Arts (BEA), a company engaged in production of electric vehicles. He is interested in calculating cost of equity for BEA. Since BEA stock is not publically traded, he cannot estimate beta coefficient by regressing stock return on index return. He wants to unlever and relever equity beta of a similar company, Tesla Motors Inc (TSLA), and has requested you to calculate unlevered beta for TSLA.
From a financial database you found that equity beta of Tesla Motors Inc. is 0.7, its debt to equity rate is 2 and applicable tax rate is 35%. Just plug in the figures in the following formula to calculate the unlevered beta.
|Unlevered Beta =||0.7||= 0.3|
|1 + 2 × (1 − 35%)|
Hidayat must relever this unlevered beta (also called asset beta) in accordance with the capital structure of BEA to find applicable equity beta, which in turn can be used in CAPM to find BEA's cost of equity.
Written by Obaidullah Jan