Unlevered Value of a company represents the value as if the company were to be wholly financed by equity. Unlevered Valuation keeps out the effect of leverage when applying discounted cash flow method and the impact of leverage is taken into consideration at later stages of APV Valuation. The formula for calculating unlevered value of the company is as follows:
Note that there should always be consistency in numerator and denominator. For Unlevered value calculation as the company is considered to be unlevered, all the cash flows generated from operation are available for the equity and the cost of which is Unlevered cost of equity.
Unlevered terminal value of the company can be calculated using following formula
Cost of unlevered equity can be calculated using CAPM equation by using unlevered beta instead of levered beta.
The formula used for converting levered beta into unlevered beta is as follows:
Thus the steps taken for calculating unlevered value of company can be summarized as follows:
1. Convert Beta Firm (Beta Levered) into Beta Unlevered using Debt-equity ratio and Tax applicable to the company.
2. Use the Beta Unlevered to apply CAPM Model to estimate Unlevered Cost of Equity of the company.
3. Determine Unlevered Free Cash Flows after eliminating the impact of debt on cash flows.
4. Use Unlevered Free Cash Flows and Unlevered Cost of Equity to calculate discounted value of cash flows.
5. The summation of discounted value of Unlevered Free Cash Flows represents Unlevered Value of the company.