Definition: Unlevered beta is a financial risk measurement that compares the risk of firm without any debt to the risk of the market. In the context of financial leverage, it represents the risk of a firm’s equity in comparison to the industry it operates.
What Does Unlevered Beta Mean?
What is the definition of unlevered beta? This is made up of two different concepts. Beta, also called levered beta, is a measurement of risk comparing the volatility of a stock to the overall market. Leverage is a company’s debt. Thus, unleveraged beta measures the risk of volatility of a company without any debt compared with the market.
Firms which aggressively engage in debt financing have a high level of debt and more volatile earnings. This volatility is the financial leverage that makes the firm more sensitive to changes in the stock prices. The beta coefficient represents the impact of financial leverage on a firm’s performance and therefore, it has to be unlevered to facilitate the comparison to other firms in the sector.
Let’s look at an example.
Example
Geraldine is a financial analyst at the Bank of America. She has to work on a project that requires her to estimate the UB of the energy industry and perform a comparison within the sector. Geraldine has calculated the debt-to-equity ratio for each company. She also knows that the tax rate is 35%.
First, she has to know the levered beta. Then, she creates the following Excel file by adjusting the LB for the debt of the company using the debt to equity ratio to arrive at the UB for the company:
The unlevered beta formula is calculated like this:
beta / ( 1 + debt/equity ) x ( 1 – tax rate )
So, Geraldine calculates in Excel the UB for each company in this industry be removing the debt from the beta based on each company’s debt to equity ratio. Obviously, the UB of each firm and the average UB is lower than the levered beta. Also, firms with lower fixed costs normally have lower UBs.
Summary Definition
Define Unlevered Beta: Unlevered Beta means a measurement used in finance to judge the risk of an investment by comparing the market to a company as if it had no debt.
