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.
Levered vs unlevered beta explained simply
Levered beta includes the extra risk debt adds to a stock; unlevered beta strips it out to show the business risk alone. Unlever a comparable company's beta, then relever it at your own debt level: β_L = β_U × [1 + (1 − T) × D/E]. In the example, 1.3 unlevers to about 0.945 and relevers to about 1.65 at D/E of 1.0.
What this levered and unlevered beta lesson covers
- 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
Levered and unlevered beta formulas, explained
- 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
How to unlever and relever beta step by step (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.
Levered beta vs unlevered beta
| Levered (equity) beta | Unlevered (asset) beta | |
|---|---|---|
| Measures | Risk to shareholders, including debt | Risk of the business itself |
| Where you find it | Regressions of share returns | Calculated from levered beta |
| Changes with debt? | Yes, rises as debt rises | No |
| In the example | 1.3 (comparable), about 1.65 (yours) | About 0.945 |
Is debt dangerous for shareholders? David's take
This lesson shows the honest cost of debt: the same business goes from a beta of about 0.95 with no debt to about 1.65 at a debt-equity ratio of 1. Shareholders carry more risk and should expect more return. That's why I think of debt like fire. It can become deadly if you don't control it, but never using it is like having a car and never driving it. The formula tells you exactly how much heat you're adding.
From David's concept: Reconsidering the Debt-Free Convention. This is David's opinion, alongside the standard textbook answer above.
Harder levered beta questions
What does the extra debt do to the cost of equity?
With a 3% risk-free rate and a 6% market premium: about 3% + 0.945 × 6% ≈ 8.67% with no debt, and 3% + 1.65 × 6% ≈ 12.93% at D/E of 1.0.
Why unlever and relever instead of just using the comparable's beta?
The comparable's beta mixes its business risk with its own debt level. Stripping the debt out and adding yours back gives a beta that matches your company's financing.
Common levered and unlevered beta 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.