How is Un-Levered Beta calculated?

How is Un-Levered Beta calculated?

• A. Levered Beta / (1 + ((1-tax rate) * (Total Debt/Equity)))
• B. Levered Beta * (1 + (Total Debt/Equity))
• C. Levered Beta * (1 - tax rate)
• D. Beta of Comparable Companies

Answer: (A)

The calculation of Un-Levered Beta aims to reflect a company's risk without the effects of debt financing. This is important as it allows investors to compare the inherent risk of a firm with different capital structures. To calculate Un-Levered Beta, the formula involves taking the Levered Beta and adjusting it for the company's capital structure. Levered Beta captures the risk of a company that is influenced by both its operational risk and the risk added through debt. The correct method to strip out the effects of debt is to use Levered Beta in conjunction with the firm's capital structure, represented through its debt-to-equity ratio and adjusted for the tax shield provided by interest payments. The formula derives from the relationship between the Levered Beta and Un-Levered Beta by accounting for the tax factor associated with the debt. The full formula applies the Levered Beta divided by the adjustment factor that includes both the tax rate and the ratio of debt to equity. This ensures that Un-Levered Beta accurately reflects the business risk, unimpeded by financial leverage. Thus, this correct approach provides a clear view of the firm's risk level, making it a fundamental concept in finance for comparing investment opportunities without the distortion created by different capital structures.

The calculation of Un-Levered Beta aims to reflect a company's risk without the effects of debt financing. This is important as it allows investors to compare the inherent risk of a firm with different capital structures.

To calculate Un-Levered Beta, the formula involves taking the Levered Beta and adjusting it for the company's capital structure. Levered Beta captures the risk of a company that is influenced by both its operational risk and the risk added through debt. The correct method to strip out the effects of debt is to use Levered Beta in conjunction with the firm's capital structure, represented through its debt-to-equity ratio and adjusted for the tax shield provided by interest payments.

The formula derives from the relationship between the Levered Beta and Un-Levered Beta by accounting for the tax factor associated with the debt. The full formula applies the Levered Beta divided by the adjustment factor that includes both the tax rate and the ratio of debt to equity. This ensures that Un-Levered Beta accurately reflects the business risk, unimpeded by financial leverage.

Thus, this correct approach provides a clear view of the firm's risk level, making it a fundamental concept in finance for comparing investment opportunities without the distortion created by different capital structures.