Cost of Capital and Valuation
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In this appendix, we discuss an alternative way to estimate the cost of capital for a firm that changes its capital structure (or has comparables with different financing policies). Instead of unlevering and relevering the cost of capital, we unlever and relever the corresponding betas and then derive the new cost of capital based on the relevered betas. This is the standard approach used in most textbooks and by most practitioners. We show that the two approaches of unlevering and relevering (the cost of capital vs. the betas) are fully consistent. We also show that the simplified equations that most people use to unlever and relever betas substantially bias the resulting WACC estimate. Finally, we provide a simple excel file that allows us to unlever and relever the firm's betas without this bias.