Unlevering and relevering
DCFStripping leverage out of peer betas and adding it back at your target's capital structure, so business risk is compared like for like.
Observed betas cannot be averaged across companies with different debt loads, because each one reflects that company's own financing. Unlevering removes that effect, leaving a comparable measure of business risk.
The procedure has three steps. Unlever each peer's levered beta using its own debt to equity ratio and tax rate to get its asset beta. Average or take the median of those asset betas, giving a sector view of business risk. Relever that figure at your target's capital structure and tax rate.
Use the target capital structure rather than today's snapshot. If a company is temporarily over levered after an acquisition and intends to pay down, relevering at today's ratio embeds a financing position nobody expects to persist.
It matters most for private companies and divisions, which have no observable beta at all. The whole point is to borrow the market's view of an industry's risk and apply it to a business the market does not price.
Worked example
A private target has no observable beta. Its listed peers average an asset beta of 0.98 once unlevered.
The target intends to run at 0.35 debt to equity, so relevered beta is 0.98 times one plus 0.75 times 0.35, or 1.24.
Use the target capital structure rather than today's. A company temporarily over levered after an acquisition should not carry a beta reflecting a position it intends to unwind.