Leveraged beta

Leveraged beta

The beta of a leveraged required return; that is, the beta as adjusted for the degree of leverage in the firm's capital structure.
Copyright © 2012, Campbell R. Harvey. All Rights Reserved.

Leveraged Beta

The volatility of a company relative to the market as a whole after adjusting for the amount of leverage. The leveraged beta is often lower than the unlevered beta (that is, the leveraged beta indicates less volatility) because debt can result in tax advantages that reduce volatility. See also: Beta.
Farlex Financial Dictionary. © 2012 Farlex, Inc. All Rights Reserved
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Table 1 The unchanged WACC according to Modigliani and Miller's theory FCF 100 100 Perpetuity growth = g 3.00% 3.00% Risk free rate = r 2.00% 2.00% Market risk premium 7.00% 7.00% Unleveraged beta = [beta] * 0.90 0.90 Cost of debt Pretax cost of debt 3.40% 5.50% Post tax @ 36.1% 2.17% 3.51% Beta of the debt 0.20 0.50 Leveraged beta = [beta] 1.20 1.07 Cost of equity = k 10.38% 9.49% WACC = K 7.11% 7.11% P 8.30% 8.30% Adjusted cost of capital 7.11% 7.11% EV 2,509 2,509 Debt 1,000 1,000 Equity 1,509 1,509 For a FCF which is equal to 100, a risk free rate of 2%, a market risk premium of 7% and an unleveraged beta of 0.9, 2 assumptions regarding the pretax cost of debt are taken into account: 3.40%, based on a debt's beta of 0.20 and 5.50% based on debt's beta of 0.50.
The WACC calculation is a bit subjective as a lot of assumptions have to be taken into account: the market risk premium depends on a assumption regarding the perpetuity growth rate of the listed firms' dividends; when the firm is listed, the cost of equity can either include its beta (which is different according to the data provider) or a leveraged beta based on the industry's unleveraged beta, which depends on the peers which have been included in the sample; the weighting coefficients can correspond to a target--or normative--financial structure or be based on an iterative calculation.
The perception that that asset class is predominantly leveraged beta will gain more credibility among its institutional clients.
In this way, leveraged beta (beta for investment in shareholders' equity or own capital beta) is determined both by the risk of the sector where the company operates and by the amount of assumed financial leverage risk.
Concerning the investigation of the company's systematic risk variation, the beta of leveraged companies, according to Rai (2005), under the assumption of non-existence of risk-free rates and assets, leveraged beta and non-averaged beta may be related by the equation (1):