De and re-levering betas with risky debt

De- and re-levering betas is important to obtain discount rates for assets that are not publicly traded. A de- and re-levering procedure is around for the case of risk-free debt. The procedure for risky debt is much less clear even under very simplifying assumptions. In this paper, I concretize and...

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Bibliographic Details
Published in:Business Research 2019-12, Vol.12 (2), p.703-720
Main Author: Krause, Marko Volker
Format: Article
Language:English
Subjects:
Accounting/Auditing
Beta
Betas
Bonds
Business and Management
Business Strategy/Leadership
Corporate Finance
Debt cancellation
Default
Default risk
Leverage
Marketing
Original Research
Tax treatment of default
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Summary:De- and re-levering betas is important to obtain discount rates for assets that are not publicly traded. A de- and re-levering procedure is around for the case of risk-free debt. The procedure for risky debt is much less clear even under very simplifying assumptions. In this paper, I concretize and extend the procedure for de- and re-levering of betas for companies with risky debt. I derive procedures for different assumptions on the taxation of a cancellation of debt (COD) and for different assumptions regarding the distribution of losses on interest and principal payments. With a tax on the COD I obtain known results. However, without taxes on a COD, the distribution of losses on interest and principal payments matters and equations differ markedly for different assumptions on the assignment of losses to interest and principal payments. Furthermore, using a procedure that does not fit the COD treatment is likely to lead to substantial deviations for de- and re-levered betas from their correct values.
ISSN:2198-2627
2198-3402
1866-8658
2198-2627
DOI:10.1007/s40685-018-0066-2