A technical note on Unlevered Beta

A technical note on Unlevered Beta

Basic derivation of unlevered beta assuming tax shield to have no beta

(V-Dt) Beta
Or;

UL

(V-Dt)) Beta

= (E) Beta e + (D-Dt) Beta

UL

= (E) Beta e + D (1-t) Beta

Note that the bold variables removes the beta contribution from the tax shield Dt
Dividing through by (V-Dt) gives
Beta

UL

= ((E) Beta e + D (1-t) Beta d) / (V-Dt)

Or,

Beta

UL

= ((E) Beta e + D (1-t) Beta d) / (E+D-Dt)

Or,

Beta

UL

= ((E) Beta e + D (1-t) Beta d) / (E+D (1-t))

Expressing as a fraction of E gives

Or

Beta

UL

= (Beta e + (1-t) D/E Beta d) / (E+D (1-t))

Beta

UL

= Beta L / (1+(D/E) (1-t))

This derivation assumes tax shield beta as insignificant which can result only from a
constant D. A constant D implies that as E changes the V changes and the D/V
keeps on fluctuating.

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A technical note on Unlevered Beta

Consider the following cases

Debt

Constant.fluctuating D/V
constant D/V

Fluctuating ...to maintain a

So if D has a zero beta then

Even if Debt has a zero beta

Dt will also have a zero beta

market why?

Dt will fluctuate as per the

Tax shield Dt will fluctuate if D
fluctuates in order to maintain D/V a
constant. This will happen even if D
has a zero beta. Since Dt is fluctuating
in response to changes in E,
fluctuation in Dt will result in a similar
beta contribution as that of equity.

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A technical note on Unlevered Beta

Remember
That in
(V-Dt) Beta

UL

= (E) Beta e + (D-Dt) Beta

Dt was excluded on the pretext that tax shield has no significant beta contribution
and the Unlevered beta is a weighted combination of Equity beta and the Debt beta
excluding the tax shield portion which can be had if Debt is held as a constant and
D/V is assumed to be changing.

But in case the D/V is assumed to be constant it would imply that the Debt would
fluctuate in order to maintain the ratio as the V or E changes. This would imply a
fluctuating debt and therefore a fluctuating Dt resulting in similar risk to Dt as that
of the market. In such a case Dt cannot be excluded from the Un Levered Beta
Equation. This will result in
(V) Beta

UL

= (E) Beta e + (D) Beta

Dividing through by (V) gives

Beta

UL

= (E/V) Beta e + (D/V) Beta

If beta for the debt is assumed to be zero then

Beta

UL

= (E/V) Beta

Re arranging in terms of D/E

Beta

UL

= Beta e / (1+ (D/E)

This derivation assumes that Tax Shield has similar risk (beta) as that of equity

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