How is levered beta calculated?

• A. Unlevered beta * (1+(1-tax rate)(total debt/equity))
• B. Unlevered beta / (1+(1-tax rate)(total debt/equity))
• C. Unlevered beta + tax rate
• D. Unlevered beta - total debt

Answer: (A)

The calculation of levered beta focuses on understanding the risk that a company's equity faces due to its capital structure, particularly when debt is involved. Levered beta reflects the systematic risk of a firm that utilizes debt financing, which can amplify the risk to equity shareholders compared to a company that is entirely equity financed.

The correct method for calculating levered beta involves taking unlevered beta, which represents the risk of the firm without debt, and adjusting it based on the company's capital structure. The formula used is unlevered beta multiplied by (1 + (1 - tax rate) * (total debt/equity)). This adjustment accounts for the tax shield provided by the interest on debt, thereby reflecting the actual risk faced by equity holders when leverage is present.

The factor (1 - tax rate) ensures that the calculation provides a more accurate representation of risk, considering the tax advantages of debt. The total debt/equity ratio shows the extent of leverage employed by the firm, directly impacting the risk to equity holders. Thus, this formula encapsulates the transformation of risk from the firm's assets (unlevered beta) to the risk pertaining to the equity holders (levered beta) due to the influence of debt. This comprehensive approach highlights why this choice