Final answer:
Even when using Unlevered FCF, you may still un-lever and re-lever beta to assess a firm's risk in relation to its capital structure and for making valid comparisons between companies with different capital structures. This process allows for a more accurate estimation of a firm's cost of equity.
Step-by-step explanation:
When undertaking valuation or investment analysis, even if you're using Unlevered Free Cash Flow (Unlevered FCF), you might still need to un-lever and re-lever beta. Levered beta (equity beta) reflects the risk of a firm's equity considering its capital structure, meaning it includes the impact of financial leverage (debt). Unlevered beta (asset beta) removes this debt effect and shows the risk associated with a firm's assets, regardless of how it is financed.
The reason to un-lever and re-lever beta is to make valid comparisons between companies with different capital structures. When comparing companies, or transferring a beta from a comparable company to the company being analyzed, you would first un-lever the beta to remove the impact of debt from the peer company's beta. Then, you would re-lever it based on the target company's capital structure in order to estimate the beta that is applicable with its specific level of debt and equity. This allows for a more accurate estimation of the cost of equity for a firm through the Capital Asset Pricing Model (CAPM).