What is Unlevered Beta?
Unlevered beta is a measure to calculate volatility the company without debt with respect to the overall market, in simple words it is calculating beta of the company without considering the effect of debt, unlevered beta is also known as asset beta because the risk of the firm without debt is calculated just on the basis of its asset.
Unlevered Beta is the measurement of the risk of a company without the impact of debt. It is also known as Asset Beta and is used to measure the risk of an unleveraged company to the risk in the market.
- Equity Beta or Levered Beta, however, compares the volatility of a company’s stock against the returns of equity markets over a specific period. It is used to measure how sensitive a particular stock is to various macroeconomic factors.
- Since every company has a different capital structure, hence one must compare how risky an individual company’s assets are, removing any effect that debt has and only measuring how risky the equity of a company is.
- Increasing debt in a company means that it would require to commit more cash flows to service that debt, and hence there is uncertainty on the future cash flows of a company. It translates to increased risk for a company, which is due to increasing leverage rather than a result of market or macroeconomic factor risk. Hence by removing the impact of debt, it can determine the risk of only the company’s assets.
- An unlevered beta will always be lower than the levered beta since it strips off the debt component, which adds to the risk. If it is positive, investors will invest in this particular stock when the prices are expected to rise. If the unlevered beta is negative, investors will invest in the stock when the prices are expected to fall.
Unlevered Beta Formula
You can calculate Unlevered Beta using the below formula –
Example of Unlevered Beta Calculation
Let us take an example of company X, which has a beta of 1.5 to the market. The Debt/Equity ratio for the company is 2:3, and the tax rate is 30%.
Hence Unlevered Beta formula = 1.5 / 1 + (1-0.3)0.66
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Unlevered Beta = 1.03
Relevance and Use of Unlevered Beta
- Unlevered beta is used when an investor wants to measure the performance of a stock, which is publicly traded in relation to market movements without the positive effect of debt taken up the company. A levered beta indicates the sensitivity of a company’s stock price to overall market movements. A positive levered beta indicates that when market performance is good, then stock prices will rise, and negative levered beta indicates that when market performance is poor, stock prices will fall.
- An unlevered beta formula measures the performance and volatility of stock without the tax advantages of debt. As the effect of debt is removed, companies with varying capital structures can be compared to measure how risky a particular company’s assets are.
- Investors calculate unlevered beta and use it for comparison by stripping off the impact of debt in the capital structure of the company.
- Also, various equity analysts use this beta to build multiple financial models for their investors, which provide more information than just a basic scenario.
- Also, another factor to be kept in mind is that if a company has a high debt to equity ratio, but all debt is rated AAA. It has inherently less risk than a company with a high debt to equity ratio but has a debt rated below the investment grade.
The Unlevered Beta formula is the measurement of the risk of a company with the impact of debt. It measures the risk of the business of the firm, which is unleveraged to the risk of the market. It will always be lower than the levered beta since it strips off the debt component, which adds to the risk.
If the unlevered beta is positive, investors will invest in this particular stock when the prices are expected to rise. If the unlevered beta is negative, investors will invest in the stock when the prices are expected to fall. It measures the performance and volatility of stock without the tax advantages of debt. As the effect of debt is removed, companies with varying capital structures can be compared to measure how risky a particular company’s assets are.
This article has been a guide to what is Unlevered Beta and its definition. Here we discuss the unlevered beta formula and how to calculate Unlevered Beta along with an example and its uses. You can learn more about from the following articles –