How to Unlever and Relever Beta in Company Valuation
Beta measures how much a company's share price moves compared with the market. It is a key input in the cost of equity, but there is a catch: a company's observed beta reflects both its business risk and the debt it carries. If you borrow a beta from a peer with a different capital structure, you import their financial risk along with their business risk. Unlevering and relevering beta fixes this.
Why It Is Needed
Two companies in the same industry can have different betas simply because one uses more debt. More debt means shareholders carry more risk, which pushes the equity beta up.
When valuing a private company, you usually have no beta of its own. You take betas from listed peers, strip out their debt effects, and then add back the debt level that suits the company you are valuing. This gives a beta that reflects the right business risk and the right financial risk.
The Three Terms
- Levered beta: the beta you observe, which includes the effect of debt.
- Unlevered beta (asset beta): the beta of the business alone, as if it had no debt.
- Relevered beta: the unlevered beta adjusted for the target company's own capital structure.
Step 1: Unlever Each Peer's Beta
A widely used approach is the Hamada formula:
Unlevered beta = Levered beta ÷ [1 + (1 − tax rate) × (Debt ÷ Equity)]
Use market values for debt and equity where possible, and the tax rate applicable to that peer.
Example: A peer has a levered beta of 1.20, a debt-to-equity ratio of 0.50 and a tax rate of 25%.
Unlevered beta = 1.20 ÷ [1 + 0.75 × 0.50] = 1.20 ÷ 1.375 = 0.87
Repeat this for every peer in the set.
Step 2: Take the Median or Average
Combine the unlevered betas of the peer group, usually using the median to limit the effect of outliers. Check that the peers truly share your company's business model, geography and size. A tidy formula cannot rescue a poor peer set.
Step 3: Relever at the Target Capital Structure
Now apply the target company's debt-to-equity ratio:
Relevered beta = Unlevered beta × [1 + (1 − tax rate) × (Debt ÷ Equity)]
Example: The target company is expected to run at a debt-to-equity ratio of 0.25, with a 25% tax rate.
Relevered beta = 0.87 × [1 + 0.75 × 0.25] = 0.87 × 1.1875 = 1.04
This beta then goes into the CAPM to calculate the cost of equity.
Which Capital Structure Should You Use?
The target's own debt level is not always the answer. Valuers often use an industry-average or optimal structure, particularly for a young or highly leveraged company, because it reflects what a typical market participant would assume. Whatever you pick, apply it consistently in both the beta and the WACC weights. A beta relevered at one capital structure and a WACC weighted at another is a common source of error.
Common Mistakes
- Using book values instead of market values for debt and equity.
- Ignoring tax rates, or using the wrong country's rate for a foreign peer.
- Skipping the unlevering step and averaging raw betas from firms with very different debt levels.
- Using a thin or mismatched peer set.
- Inconsistent capital structure between the beta and the WACC.
- Assuming debt has no risk. The Hamada formula treats debt beta as zero. For highly leveraged companies, some valuers use adjusted versions of the formula.
Unlevering turns messy peer betas into a clean measure of business risk. Relevering then adjusts that measure for the capital structure of the company you are valuing. Work with market values, use a well-chosen peer group, and keep the capital structure consistent through the whole discount rate. Document each step, because the beta is one of the first inputs a reviewer will test.
