What Is Unlevered Cost of Capital?

Unlevered cost of capital is an analysis using either a hypothetical or an actual debt-free scenario to measure a company's cost to implement a particular capital project (and in some cases used to assess an entire company). Unlevered cost of capital compares the cost of capital of the project using zero debt as an alternative to a l🌊evered cost of capital investment, which means using debt as a portion of tꦿhe total capital required.

Understanding Unlevered Cost of Capital

When a company needs to raise capital for expansion or other reasons it has two options: (1) 澳洲幸运5开奖号码历史查询:debt financing, which is to borrow money through loans or bond issuances, or (2) 澳洲幸运5开奖号码历史查询:equity financing, which is the issuance of stock.

The unlevered cost of capital is generally higher than the levered cost of capital because the cost of debt is lower than the cost of equity. Borrowing money is cheaper than selling equity in the company. This is true given the tax benefit related to the interest expense paid on the debt. There are costs associated with levered projects including underwriting costs, brokerage fees, and coupon payments, however.

Nevertheless, over the life of the capital project or the firm's ongoing business operations, these costs are marginal compared to the benefits from the lower cost of debt compared to the cost of equity.

The unlevered cost of capital represents the cost of a company financing the project itself without incurring debt. It provides an implied rate of return, which helps investors make informed decisions on whether to invest. If a company fails to meet the anticipated unlevered returns, investors may reject the investment. In general, if an investor believes a stock is a high risk,🍬 it will typically be because it has a higher unlevered cost of capital, other aspects being constant.

The 澳洲幸运5开奖号码历史查询:weighted average cost of capital (WACC) is another formula that investors and companieꦚs use to determine whether an investment is worth the cost. WACC takes into consideration the entire capital structure of a firm, which includes common stock, preferred stock, bonds, and any other long-term debt.

Formula and Calculation of Unlevere𝓡d Cost of Capitꦗal

Several factors are necessary to calculate the unlevered cost of capital, which includes 澳洲幸运5开奖号码历史查询:unlevered beta, 澳洲幸运5开奖号码历史查询:market risk premium, and the 澳洲幸运5开奖号码历史查询:risk-free rate of return. This calculation can bไe used as a standard for measuring the soundness ofౠ the investment.

The unlevered beta represents an investment's volatility as 澳洲幸运5开奖号码历史查询:compared to the market. The unlevered beta, also known as asset beta, is determined by comparing the company to similar companies with known levered betas, often by using an average of multiple betas to derive an e♌stimate. The calculation of market risk premium is t𝕴he difference between expected market returns and the risk-free rate of return.

Once all variables are known, the unlevered cost of capital can be calculated with the f🏅ormula:

Unlevered Cost of Capital = Risk-Free Rate + Unlevered Beta * (Market Risk Premium)

If the result of the calculation produces an unlevered cost of capital higher than the company's return, then further analysis should be conducted. The comparison of the result to the cost of a company's debt can determine the benefits of incurring debt and utilizing leverage to lower the cost of total capital, including equity and debt.

The Bottom Line

Unlevered cost of capital analyzes a company's ability to finance a project without debt. It allows insight into a company's cost structure in a debt-free scenario. As debt financing is cheaper than equity financing, the unlevered cost of capital is usually higher than the levered cost of capital.

Companies use this metri𒁃c to evaluate a potential investment: the risks, the costs, etc. If the unlevered cost of capital is too high, it may indicate a higher risk. When comparing tꦰo the cost of debt, companies can determine whether leveraging their position will reduce overall capital costs.