Levered beta

The levered beta (or equity beta) measures the sensitivity of a company's equity return to overall market movements, incorporating the amplification effect of financial leverage. It is higher than the unlevered (asset) beta as soon as the company carries debt, because leverage concentrates business risk on a thinner equity base. It is the beta used in the CAPM to estimate the cost of equity: ke = Rf + levered beta × (Rm - Rf), where Rm - Rf is the market risk premium. In practice, levered betas of listed comparables are first unlevered to strip out their capital structures, averaged, then relevered at the target's own structure (the Hamada framework) before entering the CAPM. The result is highly sensitive to the debt-to-equity ratio retained, which should reflect a sustainable target structure at market values.

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The levered beta formula, known as the Hamada relevering formula, reads: levered beta = unlevered beta × (1 + (1 - tax rate) × Debt/Equity). For an unlisted company, practitioners take the unlevered beta of a set of listed sector peers and relever it to the target's own gearing, based either on the actual capital structure or on a normative target structure. The choice between actual and target gearing, and between the Hamada and Modigliani-Miller variants (with or without a debt beta), can move the cost of equity by several dozen basis points and must be documented in the valuation report. In M&A practice, the relevered beta is recalculated at each valuation date, since peer betas, tax rates and the target's leverage all drift over time.

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Worked example: a sector peer set shows an unlevered beta of 0.85. Relevered to the target's capital structure (net debt/equity of 50%, tax rate of 14%), the levered beta is 0.85 × (1 + (1 - 0.14) × 0.50) = 1.22. Applied in the CAPM with Rf = 1.0% and a 6.5% market risk premium, the cost of equity is 1.0% + 1.22 × 6.5% = 8.9%, typically the dominant component of the WACC for a Swiss SME with moderate leverage.

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At Hectelion, levered beta construction for unlisted companies is carefully documented with justified capital structure assumptions, a key focus of every valuation report.