Valutico

Unlevered beta (βu), also called asset beta, represents the beta of a company without the effects of debt. It measures the systematic risk of a company's assets, independent of its capital structure

Beta quantifies how much a company's return moves relative to the overall market return.

Unlevered Beta isolates the business risk, excluding the effects of financial leverage (debt).

- Beta quantifies how much a company's return moves relative to the overall market return.
- Unlevered Beta isolates the business risk, excluding the effects of financial leverage (debt).

The relationship between Levered Beta (Equity Beta) and Unlevered Beta is:

<code> βᵤ</code><code>: Unlevered Beta</code>

<code> βₑ</code><code>: Levered Beta (Equity Beta)</code>

<code> t</code><code>: Corporate Tax Rate</code>

<code> E</code><code>: Equity</code>

- <code> βᵤ</code><code>: Unlevered Beta</code>
- <code> βₑ</code><code>: Levered Beta (Equity Beta)</code>
- <code> t</code><code>: Corporate Tax Rate</code>
- <code> D</code><code>: Debt</code>
- <code> E</code><code>: Equity</code>

This formula "removes" the influence of debt from Levered Beta, leaving just the intrinsic business risk.

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How is Unlevered Beta Used in WACC Calculation?

Unlevered Beta is crucial for calculating the Weighted Average Cost of Capital because it serves as the foundation for estimating the cost of equity. Here's how it's used step by step:

Calculate or Estimate Unlevered Beta

Use the Levered Betas of comparable companies.

Remove the effect of debt using the Unlevered Beta formula for each company.

Take the median of the peers' Unlevered Betas to estimate your company's Unlevered Beta.

- Use the Levered Betas of comparable companies.
- Remove the effect of debt using the Unlevered Beta formula for each company.
- Take the median of the peers' Unlevered Betas to estimate your company's Unlevered Beta.

The median is preferred over the average because it reduces the impact of outliers and provides a more reliable measure of business risk

Relever the Beta for the Target Capital Structure

Since most companies use debt and equity financing, you'll need to adjust the Unlevered Beta to reflect your company's or the target capital structure:

This gives the Levered Beta, reflecting both the inherent risk of the business and the added risk from the company's debt.

Use Levered Beta in the Cost of Equity Formula

The Levered Beta is then used in the Capital Asset Pricing Model:

<code>rₑ:</code><code> Cost of Equity</code>

<code>rₘ:</code><code> Market Return</code>

<code>rₘ − rᶠ:</code><code> Market Risk Premium</code>

- <code>rₑ:</code><code> Cost of Equity</code>
- <code>rᶠ:</code><code> Risk-Free Rate</code>
- <code>rₘ:</code><code> Market Return</code>
- <code>rₘ − rᶠ:</code><code> Market Risk Premium</code>

Once you have the Cost of Equity, you combine it with the Cost of Debt and weights of equity and debt to compute WACC:

<code>E</code><code>: Market Value of Equity</code>

<code>D</code><code>: Market Value of Debt</code>

<code>V = E + D</code><code>: Total Capital</code>

<code>t</code><code>: Corporate Tax Rate</code>

- <code>E</code><code>: Market Value of Equity</code>
- <code>D</code><code>: Market Value of Debt</code>
- <code>V = E + D</code><code>: Total Capital</code>
- <code>r_d</code><code>: Cost of Debt</code>
- <code>t</code><code>: Corporate Tax Rate</code>

What is Unlevered Beta?

Formula:

How is Unlevered Beta Used in WACC Calculation?

Calculate or Estimate Unlevered Beta

Relever the Beta for the Target Capital Structure

Use Levered Beta in the Cost of Equity Formula

Combine with Other Costs in WACC