Levering and Unlevering Beta Across Comparable Companies
A single company's own beta tangles together its business risk and its financing choices. Unlevering strips leverage out across a peer set; relevering puts the subject company's own capital structure back in.
How do you unlever and relever beta?
Unlevering strips a company's capital structure out of its observed beta to isolate the underlying business risk. Unlevered beta = levered beta ÷ [1 + (1 − tax rate) × D/E]. You unlever each comparable company's beta, average across the peer set, then relever that average at the subject company's own target capital structure for use in CAPM.
Key takeaways
- Unlevered beta = levered beta ÷ [1 + (1 − tax rate) × D/E]; relevering runs the same formula forward.
- A single company's observed beta mixes business risk with its own financing choices, and is often statistically noisy.
- Average the unlevered betas, never the levered ones, or you blend in each peer's capital structure.
- Relever at the subject company's own target D/E, because it is the subject company's cost of equity being built.
- The Hamada equation assumes debt carries no systematic risk of its own, which is a simplification.
Why isn't a single company's own beta good enough?
Beta measures how much a stock moves relative to the overall market, and feeds directly into CAPM's cost of equity (see the WACC guide). A single company's own observed (levered) beta reflects two things tangled together: the underlying business's operating risk, and how much financial leverage that specific company happens to carry right now. It can also simply be noisy, especially for thinly traded or recently public stocks. Practitioners deal with this by building beta from a set of comparable companies instead of trusting any one company's own number.
What are the unlevering and relevering formulas?
The Hamada equation strips a comparable company's own capital structure out of its observed beta, isolating the pure business (asset) risk underneath, and assumes debt itself carries no systematic risk of its own:
Relevering runs the same formula in reverse, at the subject company's own target capital structure and tax rate, to get the beta actually used in CAPM:
What are the steps to relever beta across a peer set?
- Unlever every comparable company's own observed beta, using each company's own D/E ratio and tax rate.
- Average the resulting unlevered (asset) betas across the peer set. This is the number that's supposed to isolate operating risk, stripped of any single peer's own financing choices.
- Relever that average at the subject company's own target D/E ratio and tax rate, since it's the subject company's cost of equity that's actually being built.
Worked example: relevering beta across three comparable companies
Three comparable companies, each unlevered at a 25% tax rate:
Peer B: levered beta 1.10, D/E 0.20 ⇒ unlevered = 1.10 ÷ (1 + 0.75×0.20) = 1.10 ÷ 1.15 = 0.957
Peer C: levered beta 1.50, D/E 1.00 ⇒ unlevered = 1.50 ÷ (1 + 0.75×1.00) = 1.50 ÷ 1.75 = 0.857
Average unlevered beta = (0.945 + 0.957 + 0.857) ÷ 3 = 0.920
Relever at the subject company's own target D/E of 0.40, at the same 25% tax rate.
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Common beta interview questions
Why unlever beta before averaging across comparable companies?
Averaging levered betas directly would blend each peer's own, different capital structure into the result. Unlevering first strips that leverage effect out, so the average reflects the underlying business risk the peer set shares, before relevering at the subject company's own capital structure.
What does the Hamada equation assume about debt's own beta?
It assumes debt carries no systematic risk of its own, effectively treating debt as risk-free for the purpose of the calculation. This is a simplification that can understate the true unlevered beta for companies with meaningfully risky debt, but it's the standard version used in practice.
Why relever at the subject company's own capital structure rather than the peer average's?
The whole point of the exercise is to estimate the cost of equity for the subject company as it's actually financed (or plans to be financed), not to replicate an average peer's financing choices. Unlevering the peers removes their capital structures; relevering applies the subject company's own.
What happens to beta as a company adds more debt?
Beta rises. The same underlying business (asset) risk is now supported by a smaller equity base relative to a larger debt load, so equity holders bear more risk per dollar of equity, which is exactly what the relevering formula captures.
Can unlevered beta differ meaningfully across companies in the same industry?
Yes. Unlevered beta reflects the underlying operating risk of the business itself, which can differ even within an industry based on factors like cyclicality of demand or how much fixed cost is embedded in the operating structure, independent of financial leverage entirely.