How to Calculate Cost of Unlevered Equity

Unlevered or unleveraged equity means the stock of an organization which is financing operations without debt and entire equity. It is necessary to know how to calculate unlevered equity if you are investing in the share market. The cost of capital is just the cost of equity as there is no debt. A debt is costlier for companies than equity, so the diversity between the costs of capital for an organization with unlevered equity and an organization with levered equity can be very important. This difference creates economic rewards for organizations that raise capital without coming into the debt market. Know how to calculate cost of unlevered equity here, it is a very long process. It has been tried here to make it understandable in very easy steps.

Steps for calculation

  • Find out the risk free rate. This is generally the interest rate on treasury bonds for 10 years. You can search this rate online or in the business section of a newspaper.
  • Find out the expected market return. The expected rate of return is actually the average market return. Generally investors use 10 % as an average stock market return during the period of 10 years.
  • Find out the cost of equity. The formula for the cost of equity without debt is:

rf + bu (rm – rf)

Here,

  1. rf is the risk-free rate
  2. bu is the delivered beta
  3. rm is the expected market return
  • Find out unlevered beta. The formula for unlevered beta is:

b (unlevered) / [1 + (1 - Tc) x (D / E) ]

Here,

  1. b is the beta with leverage of the firm
  2. Tc is the corporate tax rate
  3. D / E is the debt to equity ratio of the company
  • Find out beta. The Wall Street Journal generally accounts the beta for a stock.
  • Alternatively, you can ask this information from your broker or search the data on a business research website.
  1. A beta of 1 is said to be neutral
  2. A beta over 1 have more risk
  3. A beta less than 1 have less risk
  • Ask for the annual report from the investor relationship department of the company or download it from the website. If you do not find it then ask your broker or download it from a business research site.
  • The corporate tax rate is in the notes of the financial statement of the taxes. You should use the efficient tax rate.
  • Find out the debt to equity ratio. You can find out this on a business research site also or compute it by dividing total debt by total equity of the stockholder. Both of this line information is to be found on the balance sheet.
  • Compute de levered beta first and then replace it into the cost of equity equation for the unlevered cost of equity.
  • The final result you have found now is the cost of unlevered equity.

Calculating cost of unlevered equity is a little tricky and a time-consuming process that needs lots of information and depends upon many formulas. Here in this article, it has been tried to make it easy and understandable for you. I hope this article would have proved beneficial to you in learning how to calculate cost of unlevered equity.


Related Content:

  1. How to Calculate Cost of Capital
  2. How to Calculate Return on Equity
  3. How to Calculate Equity
  4. How to Calculate Cost of Living
  5. How to Calculate Variable Cost

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