Given the current DE ratio differs from the target DE ratio

Given the current D/E ratio differs from the target D/E ratio should we adjust the company\'s equity beta (1.25) to reflect the target capital structure?

Solution

Yes first unlever the beta using the current capital structure. Finally calculate the levered beta using the new capital structure.

Unlevered beta = 1.25/(1 + (current debt/equity)*(1-tax rate))

levered beta or adjusted beta = unlevered beta * (1 + (target debt/equity)*(1-tax rate))