Beta, Unlevering, and Relevering for WACC Interviews

Beta is the risk dial inside CAPM. Interviewers ask about it to see whether you understand that equity risk changes with leverage, and that you cannot paste a peer's levered beta onto a target with a different capital structure without thinking. You do not need to be a quant. You need clean intuition and the unlever / relever story.

The short answer

"Beta in CAPM scales the equity risk premium into cost of equity. Observed equity betas are levered. I unlever peer betas to compare operating risk, then relever at the target capital structure I use in WACC. More debt raises levered beta and cost of equity, all else equal."

Where beta sits

Cost of Equity = Rf + β × Equity Risk Premium

Higher beta → higher cost of equity → higher WACC (all else equal) → lower DCF value.

Levered vs unlevered beta

Levered beta reflects business risk plus financial leverage. It is what you usually observe from equity returns.

Unlevered beta strips out financial leverage to approximate asset / operating risk. Useful when comparing peers with different debt loads.

Unlevered β ≈ Levered β / (1 + (1 − t) × D/E)
Relevered β ≈ Unlevered β × (1 + (1 − t) × D/E_target)

Exact textbook variants differ (debt beta assumptions, lease treatment). In interviews, state the formula you are using and why.

Process for a comps-based beta

Why this matters

If Peer A is 60% debt and Peer B is nearly all equity, their levered betas are not comparable raw. Unlevering is how you avoid baking Peer A's capital structure into your target's cost of equity by accident.

Mini intuition: suppose two peers have the same unlevered beta of 0.9. Peer A at high D/E relevers to something meaningfully above Peer B at low D/E. If you average their levered betas without unlevering, you silently average capital structures, not just operating risk.

Interview prompts

"What is beta?" Sensitivity of the equity's returns to the market. In CAPM it scales the equity risk premium.

"What happens to beta if the company takes on more debt?" Levered equity beta rises because equity sits under more fixed claims. Equity becomes riskier.

"Should WACC use current or target leverage?" Often target long-term structure for a going-concern DCF. State the assumption. Relever beta to match.

"Raw beta vs adjusted beta?" Some services pull betas toward 1.0 (adjusted). Mention if you use Bloomberg-style adjusted betas. Be consistent.

"What about private companies?" No clean equity beta from trading. Use peer unlever / relever, or a sector beta, then apply target leverage.

Weak vs strong

Common mistakes

That last point is a frequent trap. Cheaper after-tax debt can pull WACC down, but higher leverage raises equity beta and Ke. Optimal capital structure is a tradeoff, not "more debt always lowers WACC."

30-second verbal

"Beta scales market risk into cost of equity via CAPM. I unlever peer betas to isolate operating risk, average them, then relever at the target D/E used in WACC. More debt raises levered beta. I keep beta and capital structure assumptions matched so the discount rate is coherent."

Practice

Write the unlever and relever formulas from memory. Build a tiny peer table on paper with three D/E ratios and show how levered betas compress after unlevering. Connect it to a DCF WACC on Project Catalyst. Pair with What is WACC and WACC / CAPM explained.