Walk through the complete steps for re-levering beta when valuing a target in an acquisition where the acquirer plans to recapitalize the target with a new, higher debt level. Assume the target currently has D/E of 0.3, equity beta 1.2, tax rate 25%, acquirer's target D/E for the target is 1.0.

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Unlever the target's current equity beta to remove the effect of its existing capital structure: βu = 1.2 / (1 + 0.75 × 0.3) = 1.2 / 1.225 = 0.9796. This unlevered beta reflects the target's business risk alone. Re-lever to the post-acquisition target D/E of 1.0: βl,new = 0.9796 × (1 + 0.75 × 1.0) = 0.9796 × 1.75 = 1.7143. The target's cost of equity under the new structure is then calculated using this new leveraged beta. The WACC will use the new capital structure weights (50% debt, 50% equity). This process ensures the discount rate matches the risk of the cash flows generated under the post-acquisition capital structure. Follow-up pressure: What if the acquirer’s own beta is lower than the target’s? Should you use the acquirer’s beta? Explain why not. If the acquisition is financed with a bridge loan that will be paid down rapidly, does your target D/E reflect the bridge or the steady-state structure? How do you handle the transition?

Line item	Year 1	Year 2	Year 3	Year 4	Year 5
Free cash flow	50	54	58	63	68
PV of free cash flow	45	45	44	43	42

Terminal value (Year 5 exit)	1,001
PV of terminal value	621
Implied enterprise value	840

Relevering Beta for an Acquisition, Explained

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