Unlevered Beta Spreadsheet
The Beta is a measure of the risk of a company. In general, when considering the risks
of a company, we can categorize them into financial and business risks. The business
risk relates to the risk of running the business while financial risk relates to the risk of
borrowing money for running the business. Sometimes, it is useful to just compare the
business risk of the different companies without the effects of the financial risk. Or in
other words, compare risks without the effects of leverage.
Unlevering a Beta allows us to remove the financial risk or effects of leverage, i.e. to
consider the risk of a company assuming it has zero debt.
Unlevered Beta Worksheet
This worksheet shows us how to calculate the Unlevered Beta from the company's Beta.
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Tax Rate(T)* - The Tax Rate of the company.
Levered Beta (B)* - The company's leverage Beta, also known as the Stock Beta.
Debt to Equity Ratio (DER)* - The company's debt to equity ratio.
Unlevered Beta - The Unlevered Beta is calculated as follows:
Unlevered Beta = Levered Beta * (1 / (1 + (1 - Tax Rate) * Debt to Equity Ratio))
Levered Beta Worksheet
The Levered Beta can be calculated from the Unlevered Beta through the following
worksheet
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Tax Rate(T)* - The Tax Rate of the company.
Unlevered Beta* - The company's beta without the effects of leverage.
Debt to Equity Ratio (DER)* - The company's debt to equity ratio.
Levered Beta (B) - The Levered Beta is calculated as follows:
Levered Beta = Unlevered Beta * (1+ ((1-Tax Rate)*Debt to Equity Ratio))
Equity beta = how volatile a given stock's price movements tend to be relative to the
overall market's movements. Takes into account the company's capital structure (so if a
company loads up on debt you will see that it tends to be more volatile than it would
otherwise be as it trades in the stock market).
Asset beta = how volatile the underlying business is, irrespective of capital structure.
You calculate asset beta by stripping out the capital structure impacts on the equity
beta.
asset beta = equity beta / (1+(1-taxrate)*(debt/equity ratio))
An asset beta is important because you can compare companies and not have the
comparison be affected by capital structure choices. What is frequently done to figure
out a company's discount rate is to take the average asset beta of the company's peers
and then re-adjust that asset beta into an equity beta based on what you think the
right long-term capital structure is.
Debt to Equity Ratio:
Definition:
Debt-to-Equity ratioindicates the relationship between the external equities or outsiders
funds and the internal equities or shareholders funds.
It is also known asexternal internal equity ratio. It is determined to ascertain soundness
of the long term financial policies of the company.
Formula of Debt to Equity Ratio:
Followingformulais used tocalculate debt to equity ratio
[Debt Equity Ratio= External Equities / Internal Equities]
Or
[Outsiders funds / Shareholders funds]
As a long term financial ratio it may be calculated as follows:
[Total Long Term Debts / TotalLong Term Funds]
Or
[Total Long Term Debts / Shareholders Funds]
Components:
The two basic components ofdebt to equity ratioare outsiders funds i.e. external equities
and share holders funds, i.e., internal equities. The outsiders funds include all debts /
liabilities to outsiders, whether long term or short term or whether in the form of
debentures, bonds, mortgages or bills. The shareholders funds consist of equity share
capital,preference sharecapital, capital reserves, revenue reserves, and reserves
representing accumulated profits and surpluses like reserves for contingencies, sinking
funds, etc. The accumulated losses and deferred expenses, if any, should be deducted from
the total to find out shareholder's funds
Some writers are of the view that current liabilities do not reflect long term commitments
and they should be excluded from outsider's funds. There are some other writers who
suggest that current liabilities should also be included in the outsider's funds tocalculatedebt
equity ratiofor the reason that like long term borrowings, current liabilities also represents
firm's obligations to outsiders and they are an important determinant of risk. However, we
advise that tocalculatedebt equity ratiocurrent liabilities should be included in outsider's
funds. The ratio calculated on the basis outsider's funds excluding liabilities may be termed
asratio of long-term debt to share holders funds.
Example:
From the following figurescalculate debt to equity ratio:
Equity share capital
Capital reserve
Profit and loss account
6% debentures
Sundry creditors
Bills payable
1,100,000
500,000
200,000
500,000
240,000
120,000
180,000
Provision for taxation
Outstanding creditors
160,000
Required:Calculate debt to equity ratio.
Calculation:
External Equities / Internal Equities
= 1,200,000 / 18,000,000
= 0.66 or 4 : 6
It means that for every four dollars worth of the creditorsinvestmentthe shareholders
haveinvestedsix dollars. That is external debts are equal to 0.66% of shareholders funds.
Significance of Debt to Equity Ratio:
Debt to equity ratioindicates the proportionate claims of owners and the outsiders against
the firms assets. The purpose is to get an idea of the cushion available to outsiders on the
liquidation of the firm. However, the interpretation of the ratio depends upon the financial
and business policy of the company. The owners want to do the business with maximum of
outsider's funds in order to take lesser risk of theirinvestmentand to increase their earnings
(per share) by paying a lower fixed rate of interest to outsiders. The outsiders creditors) on
the other hand, want that shareholders (owners) should invest and risk their share of
proportionateinvestments. A ratio of 1:1 is usually considered to be satisfactory ratio
although there cannot be rule of thumb or standard norm for all types of businesses.
Theoretically if the owners interests are greater than that of creditors, the financial position
is highly solvent. In analysis of the long-term financial position it enjoys the same
importance as the current ratio in the analysis of the short-term financial position.
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Debt-to-Equity Ratio
Debt-to-Equity ratio is the ratio of total liabilities of a business to its shareholders'
equity. It is a leverage ratio and it measures the degree to which the assets of the
business are financed by the debts and the shareholders' equity of a business.
Formula
Debt-to-equity ratio is calculated using the following formula:
Total Liabilities
Debt-to-Equity Ratio =
Shareholders' Equity
Both total liabilities and shareholders' equity figures in the above formula can be
obtained from the balance sheet of a business. A variation of the above formula uses
only the interest bearing long-term liabilities in the numerator.
Analysis
Lower values of debt-to-equity ratio are favorable indicating less risk. Higher debt-toequity ratio is unfavorable because it means that the business relies more on external
lenders thus it is at higher risk, especially at higher interest rates. A debt-to-equity
ratio of 1.00 means that half of the assets of a business are financed by debts and half
by shareholders' equity. A value higher than 1.00 means that more assets are financed
by debt that those financed by money of shareholders' and vice versa.
An increasing trend in of debt-to-equity ratio is also alarming because it means that the
percentage of assets of a business which are financed by the debts is increasing.
Example
Calculate debt-to-equity ratio of a business which has total liabilities of $3,423,000 and
shareholders' equity of $5,493,000.
Solution
Debt-to-Equity Ratio = $3,423,000 / $5,493,000 ≈ 0.62
Academic theory
Academic theory claims that higher-risk investments should have higher returns over the long-term.
Wall Street has a saying that "higher return requires higher risk", not that a risky investment will
automatically do better. Some things may just be poor investments (e.g., playing roulette). Further,
highly rational investors should consider correlated volatility (beta) instead of simple volatility
(sigma). Theoretically, a negative beta equity is possible; for example, an inverse ETF should have
negative beta to the relevant index. Also, a short position should have opposite beta.
This expected return on equity, or equivalently, a firm's cost of equity, can be estimated using
the Capital Asset Pricing Model (CAPM). According to the model, the expected return on equity is a
function of a firm's equity beta (βE) which, in turn, is a function of both leverage and asset risk (βA):
where:
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KE = firm's cost of equity
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RF = risk-free rate (the rate of return on a "risk free investment"; e.g., U.S. Treasury Bonds)
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RM = return on the market portfolio
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because:
and
Firm Value (V) + Cash and Risk-Free Securities = Debt Value (D) + Equity Value (E)
An indication of the systematic riskiness attaching to the returns on ordinary shares. It
equates to the asset Beta for an ungeared firm, or is adjusted upwards to reflect the
extra riskiness of shares in a geared firm., i.e. the Geared Beta.[4]