Beta: Levered vs. Unlevered
Levered beta measures a stock's risk including the extra risk from debt. Unlevered beta strips the debt out to show the risk of the business alone. Unlevering a comparable company's beta and relevering it at your own debt level is a standard step in valuation.
What you will learn
- Why debt makes a company's equity riskier
- The difference between levered (equity) and unlevered (asset) beta
- The Hamada formula to unlever and relever beta
- How to use a comparable company's beta for a private firm or project
- How the relevered beta feeds into CAPM and WACC
The formulas
- β_U
- unlevered (asset) beta
- β_L
- levered (equity) beta
- T
- corporate tax rate
- D/E
- debt-to-equity ratio, ideally at market values
- D/E
- the target company's own debt-to-equity ratio
Worked example
A comparable company has a levered beta of 1.3, D/E of 0.5 and a 25% tax rate. Your company has the same business risk but D/E of 1.0 and the same tax rate. What is your levered beta?
- Unlever: 1 + (1 − 0.25) × 0.5 = 1.375
- β_U = 1.3 ÷ 1.375 ≈ 0.945
- Relever: 1 + (1 − 0.25) × 1.0 = 1.75
- β_L = 0.945 × 1.75 ≈ 1.65
Answer: Your levered beta ≈ 1.65 (rounded to two decimals). More debt means riskier equity.
Common questions
What is the difference between levered and unlevered beta?
Levered beta is the beta you observe for a company's stock, so it includes the extra risk shareholders bear because of debt. Unlevered beta removes the effect of debt and reflects only the risk of the underlying business assets.
How do you calculate unlevered beta?
Divide levered beta by one plus (one minus the tax rate) times the debt-to-equity ratio: β_U = β_L ÷ [1 + (1 − T) × D/E]. This is the Hamada formula and assumes the company's debt itself carries no market risk.
Why do you unlever and relever beta?
Comparable companies have different amounts of debt, so their betas are not directly comparable. Unlevering puts them on an equal, debt-free basis. Relevering at your own company's debt-to-equity ratio gives an equity beta you can use in CAPM.
Is unlevered beta always lower than levered beta?
For a company with debt and a positive debt-to-equity ratio, yes, under the Hamada formula. For a company with no debt the two are equal. Debt adds financial risk on top of business risk, which pushes the equity beta higher.