Unlevered Beta: Definition, Formula, Example, and Use

What unlevered beta is

Unlevered beta (also called asset beta) measures a company’s systematic market risk attributable to its assets, excluding the effects of financial leverage (debt). It isolates how sensitive the company’s underlying business is to market movements by removing the impact of capital structure.

Why it matters

• Enables apples-to-apples comparisons of business risk across firms with different debt levels.
• Used in valuation (e.g., to estimate a firm’s cost of capital or to derive a project/asset beta).
• Helps separate operational risk (asset risk) from financial risk (leverage).

Beta basics

• Beta (β) measures a security’s volatility relative to the market (systematic risk).
• β = 1 → same risk as the market; β > 1 → more volatile; β < 1 → less volatile.
• Levered beta (equity beta) reflects both business risk and financial leverage.

Formula

Unlevered beta is derived from levered beta using the company’s debt-to-equity ratio and the corporate tax rate:

Unlevered beta = Levered beta / [1 + (1 − tax rate) × (Debt / Equity)]

Or equivalently:

β_unlevered = β_levered ÷ (1 + (1 − T) × D/E)

Where:
– β_levered = observed equity beta
– T = corporate tax rate (decimal)
– D/E = debt-to-equity ratio

How to calculate (step-by-step)

1. Obtain the company’s levered beta (from regression or a data provider).
2. Find the company’s market-value debt and equity or a close proxy to compute D/E.
3. Choose an appropriate corporate tax rate.
4. Plug values into the formula to compute β_unlevered.

Example

Given:
– Levered beta (βL) = 0.73
– Debt/Equity = 2.2
– Tax rate = 35% (0.35)

Calculation:
β_unlevered = 0.73 ÷ [1 + (1 − 0.35) × 2.2]
β_unlevered ≈ 0.73 ÷ [1 + 0.65 × 2.2] ≈ 0.73 ÷ (1 + 1.43) ≈ 0.73 ÷ 2.43 ≈ 0.30

Notes on interpretation

• β_unlevered is generally ≤ β_levered because adding positive debt amplifies equity volatility.
• A positive β_unlevered indicates the asset’s returns move with the market; a negative β_unlevered implies inverse sensitivity.
• If a firm has net cash (negative net debt), unlevered beta can be higher than levered beta in rare cases.
• Use market-value D and E where possible. Book values can distort the result.

Practical uses

• Normalize betas for comparable-company analysis (remove capital structure differences).
• Estimate a project or divisional beta by starting with industry unlevered beta and relevering for the project’s target capital structure.
• Input to WACC and discounted cash flow (DCF) models after appropriate relevering for the firm’s planned leverage.

Limitations and caveats

• Beta is historically estimated and may not predict future sensitivity accurately.
• Choice of tax rate, debt and equity values (market vs book), and time window/market index affect results.
• Nonlinear effects (e.g., default risk, covenants) aren’t captured by this simple adjustment.
• For very small or highly cyclical firms, beta may be unstable.

Key takeaways

• Unlevered beta isolates business (asset) risk by removing leverage effects.
• Formula: β_unlevered = β_levered / [1 + (1 − T) × (D/E)].
• Useful for comparing firms, deriving asset betas, and building valuation inputs — but sensitive to input choices and estimation methods.