Unlevered Beta

What is Unlevered Beta?

Unlevered beta, also referred to as asset beta, measures the systematic risk of a company's business operations without the impact of its debt structure. While a company's total systematic risk (levered beta) is influenced by both its business risk and financial leverage, unlevered beta isolates the risk of the business assets alone.

In corporate finance, comparing the volatility of different companies can be challenging because each firm has a different capital structure. By removing the tax-shielded debt effect, investors can compare companies in the same industry on an equal footing.

The Unlevered Beta Formula

The calculation relies on the Hamada equation, which establishes the relationship between levered beta, unlevered beta, and a company's leverage structure. The standard formula is:

$$\text{Unlevered Beta} = \frac{\text{Levered Beta}}{1 + (1 - \text{Tax Rate}) \times \frac{\text{Debt}}{\text{Equity}}}$$

Where:

• Levered Beta (Equity Beta): The volatility of the company's stock relative to the overall market.
• Tax Rate: The corporate tax rate applicable to interest payments.
• Debt-to-Equity (D/E) Ratio: The proportion of company debt to shareholders' equity.

Re-levering Beta

Once you calculate the unlevered beta of an industry or peer group, you can re-lever it to estimate the appropriate equity risk for a target firm (such as a private company or a firm undergoing capital restructuring). The re-levered beta formula is:

$$\text{Levered Beta} = \text{Unlevered Beta} \times \left[1 + (1 - \text{Target Tax Rate}) \times \text{Target D/E}\right]$$

Why Compare Unlevered Beta?

Comparing companies with different debt loads using levered beta can lead to incorrect conclusions. A company with high debt will have a higher levered beta simply because of financial risk, even if its actual business model is stable. De-levering and re-levering helps valuation analysts accurately calculate the Cost of Equity using the Capital Asset Pricing Model (CAPM).

If you are evaluating cash flows, you might also be interested in our Free Cash Flow to Firm (FCFF) Calculator or Free Cash Flow to Equity (FCFE) Calculator to model the firm's valuations directly.