Unlevered Beta

Posted in Finance, Accounting and Economics Terms, Total Reads: 1092
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Definition: Unlevered Beta

Beta is a measure of volatility of a company stock with respect to the market. Thus, if a company has a beta of 1.2 and the market increases by 1%, the company stock is expected to increase by 1.2% on the average. Similarly when the market falls by 1%, the value of the company stock is expected to fall by 1.2%. Unlevered beta is a metric that measures the risk of an unlevered company as ratio of the risk of the market.


Simply put, it is the beta of a company without any debt and is the measure of the business risk, sales risk and operating risk of the company. When we unlever the beta of a company, we simply remove the financial impacts of leverage of the company. It removes the beneficial impact of adding debt to the company’s capital structure.


The metric gives a measure of how much systematic risk or country specific risks that the company carries when compared with the market risk. Comparison of unlevered betas of two companies enables investors to understand the risk in purchasing the stocks of the two companies and which company would be better to invest with. The formula of unlevered beta is given below,


Unlevered beta = Levered beta / (1 + ((1 – Tax Rate) x (Debt/Equity)))


Hence,

Levered beta = Unlevered beta x (1 + ((1 – Tax Rate) x (Debt/Equity)))


Unlevered beta (or asset beta) = Equity beta x (Equity / ((1-Tax Rate) x Debt + Equity)) + Debt beta x (((1-Tax Rate) x Debt) / ((1-Tax Rate) x Debt + Equity))


Assuming that debt beta (the probability that the company will default on its debt taken) is zero,

Asset Beta = Equity beta x (1 / ((1-Tax Rate) x (Debt/Equity) + 1))


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