DCF

Levered vs. unlevered beta

4 min read · updated July 2, 2026

Beta measures how much a stock moves with the market, and it's the only company-specific dial in CAPM. But here's the catch that trips people up: the beta you observe for a public company is polluted by that company's debt. Two identical businesses with different debt loads will show different betas, purely because of how they're financed. So before you use a beta, you scrub the financing out.

That scrub is the levering/unlevering process, and it's one of the most common "do you actually understand this" questions in a valuation interview.

Why debt inflates beta

Debt adds a fixed claim that sits ahead of equity holders. Interest gets paid whether the business has a good year or a bad one. So when profits swing, the equity, which is what's left after debt is served, swings even harder. More leverage means a bumpier ride for shareholders, which shows up as a higher observed beta.

That extra bumpiness has nothing to do with the underlying business. It's just financing. So the raw beta you pull from a data service blends two things:

Business risk: how cyclical the actual operations are.
Financial risk: how much debt is amplifying those swings.

Key insight

Unlevered beta (also called asset beta) is pure business risk. It answers "how risky are these operations if the company had no debt at all." Levered beta (also called equity beta) is business risk plus financing risk. When you compare companies or value one, you want to isolate the business risk first, then bolt on the specific financing you care about.

The two-step scrub

You almost never use one company's raw beta. Instead you take a set of comparable companies, clean each one, average, then re-apply your own target's leverage.

Step 1: Unlever each comparable's beta to strip out its capital structure. This leaves the asset beta.

$\beta_{unlevered} = \frac{\beta_{levered}}{1 + (1 - t)\,\dfrac{D}{E}}$

Step 2: Relever the average asset beta at your target's debt-to-equity ratio.

$\beta_{relevered} = \beta_{unlevered} \times \left[\,1 + (1 - t)\,\dfrac{D}{E}\,\right]$

Unlevering divides; relevering multiplies. The $(1 - t)$ term is there because interest is tax-deductible, so debt's amplifying effect is slightly softened by the tax shield.

A worked example

Say the average comparable has a levered beta of 1.4, a debt-to-equity of 0.5, and the tax rate is 20%. Unlever it:

$\beta_{unlevered} = \frac{1.4}{1 + 0.8 \times 0.5} = \frac{1.4}{1.4} = 1.0$

So the pure business risk is a beta of 1.0. Now say your target carries more debt, a debt-to-equity of 1.0. Relever the asset beta at that level:

$\beta_{relevered} = 1.0 \times \left[\,1 + 0.8 \times 1.0\,\right] = 1.0 \times 1.8 = 1.8$

Your target's beta is 1.8, higher than the comp's 1.4, because your company is more leveraged. Drop that into CAPM with a 3% risk-free rate and a 6% equity risk premium and the cost of equity is $3\% + 1.8 \times 6\% = 13.8\%$ . Skip the scrub and use the comp's raw 1.4, and you'd get 11.4%, understating the risk of a more-levered business.

Why it matters

If you use a comp's levered beta straight, you're importing that comp's balance sheet into your valuation. You wanted to measure your company's risk at your company's financing, and instead you measured someone else's. The unlever-then-relever dance exists precisely to remove that noise.

It matters most when the target and the comps have very different leverage. If everyone in the peer set has roughly the same capital structure, the scrub barely moves the number. When leverage varies a lot, it moves it a lot.

Common mistake

Three flavors of the same mistake, all common in interviews:

Using the raw comp beta with no unlever/relever at all, importing the comp's leverage.
Getting the direction backwards, multiplying when you should divide. Remember: unlever out of the comp (divide), relever into your target (multiply).
Dropping the $(1 - t)$ term. The tax shield softens debt's effect on beta. Leaving it out overstates how much leverage inflates the beta.

How it fits the bigger picture

The relevered beta is the beta that goes into CAPM to get the cost of equity, which feeds WACC, which discounts cash flows in the DCF. Beta sits near the start of that chain, so getting it right ripples through the whole valuation.

Interview tip

When beta comes up, don't stop at "how much the stock moves with the market." Add the sentence that shows depth: "and I'd unlever the comps' betas to get the asset beta, then relever at my target's own debt-to-equity, so I'm capturing the business risk at the right capital structure, not importing the comps' leverage." That one line, delivered cleanly, is the depth that separates you in a Superday.

Glossary

New to the lingo? Every term used above, in plain English.

Beta: A measure of how much a stock moves relative to the overall market. A beta of 1 moves with the market, above 1 is more volatile, below 1 is less. It feeds the cost of equity.
CAPM (Capital Asset Pricing Model): The standard formula for cost of equity: the risk-free rate plus beta times the equity risk premium. It estimates the return shareholders demand for a stock risk.
Cost of equity: The return shareholders require to own a company stock, given its risk. Usually estimated with CAPM, and it is always higher than the cost of debt.
Capital structure: The mix of debt and equity a company uses to fund itself. More debt is cheaper but riskier, and finding the right balance affects both value and risk.
WACC (Weighted Average Cost of Capital): The blended rate a company pays to fund itself with both debt and equity. In a DCF it is the discount rate used to bring future cash back to today.
Equity risk premium (ERP): The extra return investors demand for holding stocks instead of risk-free government bonds. Historically it runs around 5% to 7%.

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