What’s the Unlevered Beta Formula?
“Unlevered Beta” or “unlevered beta” refers to the actual risk a company faces from its assets that are free of the financial risk associated with debt has been eliminated and, as such, is also referred to in the field of asset beta. In the sense of unlevered Beta, it is the Beta that eliminates the effect of the capital structure of a business on its risk exposure to systematic risk. Unlevered beta formula could be determined by dividing the levered Beta (a.k.a. equity beta) by a multiplier of 1. This is multiplied by one of (1 – tax rate) and the ratio of debt-to-equity of the business. Mathematically, it’s represented as
Unlevered Beta = Levered Beta / [1 + (1 – Tax Rate) * (Debt / Equity)]
What’s Unlevered Beta Formula (Asset Beta)?
The unlevered Beta (a.k.a. Asset beta) is the value of a company’s Beta that is not impacted by debt. It’s also referred to as the risk of return for a business, not considering the financial leverage. It examines the risk of an unlevered firm with those of the markets. It is often called “asset beta” because the volatility of a business that does not have leverage is due to its assets.
Equity Beta Vs. Asset Beta
The Levered Beta (or “equity beta”) is a measure that measures the risk of returns for an individual company’s stock to the market’s overall returns. It’s a risk measure and includes the effects of a company’s design and the leverage it uses. Equity beta lets investors determine how vulnerable the security is to the macro-market risk. For instance, a firm that has an equity beta of 1.5 can earn returns that are 150% more unpredictable than the markets it’s contrasted to.
If you search for the Beta of a company on Bloomberg, The default number you see is leveed, which reflects the company’s debt. Because every firm’s capital structure is unique, analysts will typically be looking at the degree to which “risky” the company’s assets include, no matter the percentage of equity or debt funding it is.
The greater a company’s leverage or debt, the higher its earnings will be from the company focused on servicing that debt. As a business adds increasing amounts of debt, the uncertainty surrounding future earnings will also increase. This raises the risk associated with the company’s stock but isn’t caused by the risks of the market or the industry. So, by eliminating the risk of financial leverage (debt impact) and the unlevered Beta can be able to capture the risk only of the company’s assets.
How do you calculate Unlevered Beta or Asset Beta?
To evaluate the potential risk for a business with no debt, we must de-lever in the Beta (i.e. take away the negative impact of debt).
To achieve this, you must search the beta value for a set of companies that are comparable to yours within the same sector, de-lever each of them, calculate the median and then re-lever it following the structure of your company’s capital.
In the end, you can utilize the unlevered beta formula Beta in the cost of equity calculation.
To help you, The Unlevered Beta Formula for levering and un-levering Beta are as follows:
Excel Example of Converting Asset Beta to Equity
Below is an example of the process to change to Equity or Asset Beta. Let’s review a few of the results to show how it is done.
The stock has an equity beta value of 1.21 and a net debt to equity ratio of 21 percentage. After deleveraging the stock, the Beta falls to 1.07, which is logical since the debt added leverage to the stock’s returns.
Stock 2 is not cash or debt, which means that the asset and equity betas are equal. This is very much logical as there is no impact of capital structure on returns.
Stock 3 has the current net cash balance (negative net debt), which means that when it’s converted, the asset beta is greater than the equity beta. This is because the cash value does not change, which means that the stock’s volatility (equity beta) is reduced due to the effects of the cash position net.
What does Asset Beta serve To Do?
Asset beta is a method of assessing the risk associated with an asset minus any business debt.
It is recommended to use asset beta when an investor or a business seeks to evaluate a company’s performance relative to the market without the influence of debt.
In contrast to the levered Beta, the asset beta doesn’t reflect financial leverage’s effect on (debt). Asset beta is often employed in financial modelling and business valuations for professionals who work in investment banking or equity research.
Beta is the best fitting line on the graph of the returns of markets against the asset’s return. In Excel, it is determined using Excel’s Slope function.
What is Unlevered Beta Formula?
Unlevered Beta is a method to determine the volatility of a company without debt about the general market. In simple terms, it calculates the Beta of the business without taking into account the impact of debt. Unlevered Beta is also referred to as asset beta as the risk of a company that is not a debtor is calculated by analyzing its assets.
Unlevered Beta is the measure of the risk posed by an organization without the burden of debt. It is also been referred to as Asset Beta and is utilized to assess a company’s vulnerability that is not leveraged to risk in the market.
Equity Beta or Levered Beta is a measure of the fluctuations of a company’s shares with the performance of equity markets over a particular time in Beta formula. It’s used to gauge the degree to which a specific stock is to macroeconomic variables.
Every firm has a unique capital structure, and one should assess each firm’s assets’ riskiness. This is done by removing the impact of debt and only evaluating the company’s riskiness of equity.
The increase in debt for a business implies that it will need to raise more cash flows to repay that debt, which means there is doubt about a business’s cash flow. This means increased risk for companies due to an increase in leverage rather than due to macroeconomic or market risk. Therefore, by eliminating the risk of debt, it is possible to assess the risk only of the company’s assets.
Unlevered betas will always be lower than the levered Beta.
Because it eliminates the debt element, which adds more risk, if it’s positively, people will be investing in this specific stock when prices are anticipated to increase. Suppose the Beta unlevered positive; investors would be investing in the stock only when prices are anticipated to decrease.
The importance and use of Unlevered Beta Formula.
Unlevered Beta can be used for investors looking to gauge how well a company’s stock is traded on the market about market fluctuations but without the benefit of the company’s debt. Levered Beta is a measure of the sensitivity of a firm’s price to market trends. A positive levered Beta indicates that when the market is positive, then stock prices will increase, while a negative one indicates that when the market is not good, prices will decline.
A formula for unlevered Beta measures the effectiveness and the volatility of stocks without the tax benefits of debt. Since the impact of debt is gone, companies with different capital structures can be compared to determine how risky a firm’s assets are.
Investors calculate unlevered Beta and apply it as a benchmark by removing the effect of debt on the business’s capital structure.
Additionally, many equity analysts use this Beta to construct different financial models for investors, which offer more detail than just a simple model.
Another aspect you need mainly keep in mind is that a company has an excessive ratio of equity to debt.
However, all debt is graded AAA. It is inherently safer than a business with an elevated equity ratio to debt but with debt below an investment grade.
The Unlevered Beta formula measures the risk a business faces that are impacted by debt. It is a measure of the risk of the firm’s operations that is not leveraged by the market risks. It is always lower than the levered Beta because it eliminates the debt component to increase the risk.
If the Beta unlevered can be positive, investors should only put their money in this particular stock when the price is expected to increase. If the Beta unlevered is negative, investors will be investing in the stock when prices are anticipated to fall. It evaluates the volatility and performance of the stock without tax advantages. When the impact of debt is gone, the companies with different capital structures can be compared to assess how risky a firm’s assets are.
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