SuperdayReps
DCF

WACC and beta (Advanced)

By SuperdayReps · Wharton MBA · ex-Greenhill · investment banking interview coaching

4 min read · updated July 30, 2026

The basic articles give you CAPM and the WACC formula. Level 4 and 5 questions attack the inputs — because that is where every real disagreement about a valuation actually lives.

Unlevering and relevering, done properly

A beta you pull off a screen is a levered beta. It reflects two things mixed together: the underlying business risk, and the financial risk created by that specific company's capital structure. Only the first is comparable across peers.

βU=βL1+(1−t)DEβL=βU[1+(1−t)DE]\beta_U = \frac{\beta_L}{1 + (1 - t)\frac{D}{E}} \qquad\qquad \beta_L = \beta_U \left[1 + (1 - t)\frac{D}{E}\right]

Worked, because the arithmetic is where people slip. A comp has a levered beta of 1.40, debt-to-equity of 0.60, tax rate 25%. Unlevered: 1.40/[1+0.75×0.60]=1.40/1.45=1.40 / [1 + 0.75 \times 0.60] = 1.40 / 1.45 = 0.966.

Your subject company targets a 0.30 debt-to-equity. Relevered: 0.966×[1+0.75×0.30]=0.966×1.225=0.966 \times [1 + 0.75 \times 0.30] = 0.966 \times 1.225 = 1.18.

That drop from 1.40 to 1.18 is not cosmetic. At a 5.5% equity risk premium, it moves cost of equity by roughly 120 basis points, which moves a DCF materially.

Key insight

The (1−t)(1 - t) term is doing real economic work, not sitting there for decoration. Debt creates a tax shield, so leverage raises equity risk by less than the raw debt-to-equity ratio suggests. Omit the tax factor and you systematically over-relever, inflate cost of equity, and undervalue every levered company you look at.

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Frequently asked

Why do you unlever and relever beta?
Observed beta reflects both business risk and the financial risk of that specific company's leverage. Unlevering strips out the capital structure to isolate business risk, which is comparable across peers. Relevering applies your subject company's target capital structure. Skipping the step means importing your comps' balance sheets into your valuation.
Should WACC use the current or target capital structure?
Target. WACC discounts cash flows over the entire forecast and into perpetuity, so it needs the structure the company is expected to maintain, not a snapshot that may be temporarily distorted. Using today's structure for a company mid-deleveraging bakes a transient leverage ratio into a perpetual discount rate.
Why use market values rather than book values for the weights?
Cost of capital is the return investors require on what they could sell their claim for today, which is a market value. Book equity is an accounting residual that can be negative or decades stale. Debt is often close enough at book, but equity must be market capitalization.
How do you estimate cost of equity for a private company?
Build it from public comps. Unlever the peer group's betas, take a median, relever at the private company's target structure, then run CAPM. Practitioners typically add a size premium and sometimes a company-specific premium, since a small private business carries risks a large-cap index does not capture.
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