How to Calculate the Unleveraged Equity

Unleveraged (unlevered) equity refers to a company that is financed completely with equity (stocks) rather than with debt and equity; that is, it is a debt-free company. The cost of capital is the cost of equity when no debt is involved. Equity is ownership, and does not need to be paid back like debt. For this reason, equity is considered to be a cheaper cost of capital than debt. The cost of equity is dependent on beta which must be delevered in order to calculate the unleveraged cost of equity.

Things You'll Need

• Calculator or spreadsheet

Instructions

1. Review the formula for the cost of equity. The formula is: rf + ba (rm - rf), where rf is the risk free rate, bu is the delevered beta, and rm is the expected market return.

2. Determine rf. Rf is the risk-free rate, which is usually the interest rate on 10-year Treasury bonds. Let's assume the current interest rate on 10-year Treasuries is 3 percent.

3. Determine rm, the expected market return. The expected rate of return is the amount you can expect on average if you invest in equities over the long term. This is generally assumed to be 10 percent.

4. Determine unlevered beta. The formula for unlevered beta is bl / [1+(1-Tc) x (D/E) ], where bl is the firm's beta with leverage,Tc is the corporate tax rate, and D/E is the company's debt-to-equity ratio.

5. Determine beta for the company. Look up the beta on your favorite investment research site. Beta is a measure of systematic risk. Let's say beta is 1.

6. Determine the corporate tax rate. You can find this in the notes to the financial statements.

7. Determine the debt-to-equity ratio. You can also find this on your favorite investment research site.

8. Compute delevered beta by inputting the numbers into the equation. Then input the delevered beta into the formula for the cost of equity.

References

• Investopedia: Unlevered Beta