Why re-lever Beta after un-levering?

Why re-lever Beta after un-levering?

• A. To compute enterprise value
• B. To adjust for tax rate differences
• C. To reflect the true risk of our company given its own capital structure
• D. To calculate WACC

Answer: (C)

Beta measures systematic risk, and it depends on how a company is financed. When you un-lever beta, you strip out the financing effect of debt to see the pure business risk—the asset beta. But to price the company's equity or to estimate its cost of capital, you need beta that reflects the actual or target debt level. Re-levering restores the financial risk by incorporating the company’s leverage, so the beta you use matches the true risk given its capital structure. That’s why re-levering after un-levering is done: to reflect the company’s risk profile under its own financing. This approach ensures the cost of equity (and the WACC derived from it) aligns with the firm’s leverage, rather than with its unlevered, purely business risk.

Beta measures systematic risk, and it depends on how a company is financed. When you un-lever beta, you strip out the financing effect of debt to see the pure business risk—the asset beta. But to price the company's equity or to estimate its cost of capital, you need beta that reflects the actual or target debt level. Re-levering restores the financial risk by incorporating the company’s leverage, so the beta you use matches the true risk given its capital structure. That’s why re-levering after un-levering is done: to reflect the company’s risk profile under its own financing. This approach ensures the cost of equity (and the WACC derived from it) aligns with the firm’s leverage, rather than with its unlevered, purely business risk.