What is Unlevered Beta and Why Should You Care?
Ever wonder how we can measure a company's volatility in relation to the entire market? That's where Unlevered Beta (also known as Asset Beta) comes in. Unlevered Beta tells us how risky a company's equity is without the influence of debt. It's like comparing apples to apples when you're analyzing companies with different levels of debt.
You should care because understanding a company's Unlevered Beta can help you make more informed investment decisions. It's a key metric for anyone wanting to dig deeper into a company's risk and return profile.
How to Calculate Unlevered Beta
Ready to dive into calculating Unlevered Beta? Follow these steps:
- Determine the Levered Beta: This is the starting point. Levered Beta can typically be found on financial information platforms or calculated based on historical data.
- Identify the Tax Rate: Look for the company's effective tax rate, which might be available in their financial statements.
- Calculate Total Debt: This includes both short-term and long-term debt.
- Measure Total Equity: This is found on the company's balance sheet and includes shareholders' equity.
- Apply the Unlevered Beta Formula:
[\text{Unlevered Beta} = \frac{\text{Levered Beta}}{1 + (1 - \text{Tax Rate}) \times \left(\frac{\text{Total Debt}}{\text{Total Equity}}\right)}]
Where:
- Levered Beta is the company's beta with its current capital structure.
- Tax Rate is the effective tax rate the company pays.
- Total Debt is the sum of the company's short-term and long-term debt.
- Total Equity is the shareholders' equity.
Calculation Example
Let's put theory into practice with an example. Assume we have a company with the following values:
- Levered Beta: 1.5
- Tax Rate: 30%
- Total Debt: $200,000
- Total Equity: $800,000
First, plug these numbers into the formula:
[\text{Unlevered Beta} = \frac{1.5}{1 + (1 - 0.3) \times \left(\frac{200000}{800000}\right)}]
Breaking it down:
[\text{Unlevered Beta} = \frac{1.5}{1 + 0.7 \times 0.25}]
[\text{Unlevered Beta} = \frac{1.5}{1 + 0.175}]
[\text{Unlevered Beta} = \frac{1.5}{1.175}]
[\text{Unlevered Beta} \approx 1.277]
So, the Unlevered Beta for this company is approximately 1.277.
In summary, Unlevered Beta offers a clear picture of how a company behaves in the market without the distortion of debt. By using the formula provided, you can make informed comparisons between companies with varying capital structures.