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Definition: Hamada Equation
Hamada equation shows the effect of debt or financial leverage on the risk coefficient of the firm. It is used to separate the financial risk of a firm from its business risk. It shows the relationship between the type of leverage and the firm’s cost of capital.
Beta Asset is not dependent on how the assets of a firm are financed and hence it is equivalent to a firm’s unlevered beta. T being the tax rate, the relationship between the levered and unlevered beta can be written as
This means that if the firm goes for leverage then it will increase its overall risk by 0.92-0.73 = 0.19 or 26%. So the Hamada equation shows the effect that the financial leverage can have on a firm’s overall risk.