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Unlevered beta is a measurement of systemic risk that ignores the capital structure of a corporation and is applied to its assets. It illustrates how susceptible the company's cash flows are to shifts in the economy or the market. Unlevered cost of equity or asset beta are other names for unlevered beta.
Unlevered beta can be calculated by adjusting the levered beta (or equity beta) for the effects of debt and taxes. The formula is:
Unlevered beta = Levered beta / (1 + (1 - tax rate) * (debt / equity))
Levered beta is the beta that investors see when buying or selling a company's stock in the market. It includes the risk associated with the company's debt as well as its assets. Debt makes a company's earnings and cash flows more volatile, which makes its stock riskier and increases its levered beta.
The tax rate refers to the actual tax rate that the business pays on its revenue. Due to the fact that interest payments are tax-deductible, taxes lessen the danger that debt poses to a corporation. The unlevered beta decreases with a higher tax rate.
The total amount of debt listed on the company's balance sheet is referred to as debt. Both short-term and long-term debt obligations are included.
Equity is the sum of all the company's equity as shown on the balance sheet. Both regular and preferred stock are included.
The risk of several businesses with various capital arrangements can be compared using unlevered beta. It can also be used to calculate the equity cost of a project or acquisition that is funded entirely by equity. Unlevered beta is the operational risk of a company's operations prior to the addition of any financial leverage.
