What is Unlevered Beta?

Explanation

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 BetaEquity BetaEquity Beta measures the volatility of the stock to the market, i.e., how sensitive is the stock price to a change in the overall market. It compares the volatility associated with the change in prices of a security. Equity Beta is commonly referred to as levered beta, i.e., a firm’s beta, which has financial leverage.read more or Levered Beta compares the volatility of a company’s stock against the returns of equity markets over a specific period. It measures how sensitive a particular stock is to various macroeconomic factorsMacroeconomic FactorsMacroeconomic factors are those that have a broad impact on the national economy, such as population, income, unemployment, investments, savings, and the rate of inflation, and are monitored by highly professional teams governed by the government or other economists.read more.  Since every company has a different capital structure, 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 more cash flows to service that debt, and hence there is uncertainty about the company’s future cash flows. It translates to increased risk for a company due to increasing leverage rather than a result of market or macroeconomic factor risk. Hence, removing the impact of debt can determine the risk of only the company’s assets.An unlevered beta will always be lower than the levered betaLevered BetaLevered beta measures the systematic risk of a stock that includes risk due to macroeconomic events like war, political events, recession, etc. Systematic risk is inherent to the entire market and is also known as undiversifiable risk.read more 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 –

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Example of Unlevered Beta Calculation

Let us take the example of company X, which has a beta of 1.5 on the market. The Debt/Equity ratio for the company is 2:3, and the tax rate is 30%.

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, concerning market movements without the positive effect of debt taken up by the company. A levered beta indicates a company’s stock price sensitivity to overall market movements. A positive levered beta indicates that when market performance is good, then stock prices will rise, and a 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 company’s capital structure.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 ratioDebt To Equity RatioThe debt to equity ratio is a representation of the company’s capital structure that determines the proportion of external liabilities to the shareholders’ equity. It helps the investors determine the organization’s leverage position and risk level. read more, 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.

Conclusion

The Unlevered Beta formula is the measurement of the risk of a company with the impact of debt. It measures the risk of the firm’s business, 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.

  • Unlevered Beta formula = 1.5 / 1 + (1-0.3)0.66 Unlevered Beta = 1.03

If the unlevered beta is positive, investors will invest in this 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 advantagesTax AdvantagesTax Advantage are the types of investments or saving plans that benefit tax exemption, deferred tax, and other tax benefits. Examples include Government bonds, Annuities, Retirement Plans. read more 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 guided what Unlevered Beta is 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 it from the following articles –

  • Beta in FinanceWhat is Volatility Formula?Beta CoefficientCalculate the WACCRandom Walk Theory