Unlevered Beta
Unlevered beta, also known as asset beta, measures a company's market risk without the impact of debt. It reflects the risk inherent in the company's core business operations, independent of its capital structure. Unlevered beta is calculated by removing the effects of financial leverage from the levered beta (traditional beta coefficient), providing investors with a clearer view of the company's fundamental risk.
Definition: Unlevered Beta is a measure of a company's market risk without any debt. It reflects the risk of the company's business itself, excluding the impact of its capital structure. By removing the effect of financial leverage, unlevered beta allows investors to more accurately assess the fundamental risk of a company.
Origin: The concept of unlevered beta originates from the Capital Asset Pricing Model (CAPM), which was introduced by William Sharpe in the 1960s. CAPM is used to evaluate the expected return of an asset, with the beta coefficient measuring the risk of the asset relative to the market. Unlevered beta further removes the impact of financial leverage, allowing investors to purely assess the business risk of a company.
Categories and Characteristics: Unlevered beta has the following characteristics:
- Excludes financial leverage: Unlevered beta does not consider the company's debt, focusing solely on business risk.
- Industry comparison: Unlevered beta can be used for industry comparisons between different companies, as it excludes the impact of capital structure.
- Risk assessment: Unlevered beta helps investors more accurately assess the fundamental risk of a company.
Specific Cases:
- Assume Company A has a levered beta of 1.5, a debt-to-equity ratio of 0.5, and a corporate tax rate of 30%. The formula for calculating unlevered beta is:
Unlevered Beta = Levered Beta / [1 + (1 - Tax Rate) * Debt-to-Equity Ratio]
Substituting the data: Unlevered Beta = 1.5 / [1 + (1 - 0.3) * 0.5] = 1.2 - Companies B and C are in the same industry but have different capital structures. By calculating unlevered beta, investors can more accurately compare the business risks of the two companies without considering their debt.
Common Questions:
- Q: What is the difference between unlevered beta and levered beta?
A: Unlevered beta excludes the impact of a company's debt, focusing on business risk, while levered beta includes the company's financial leverage. - Q: Why use unlevered beta?
A: Using unlevered beta allows for a more accurate assessment of a company's fundamental business risk, especially when making industry comparisons.
