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8/2/2019 CFM trm ppr

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Contents

INTRODUCTION: ...................................................................................................................................... 2

HOW TO CALCULATE LEVERED BETA: ....................................................................................................... 2

STEPS T O CALCULATE: ............................................................................................................................. 3

HOW TO CALCULATE UNLEVERED BETA: ......................... ................................ ...................... ................... 3

STEPS TO CALCULATE:.............................................................................................................................. 3

BETA CONCEPT: ....................................................................................................................................... 4

LEVERED COMPANY: ........................... ......................... ................................ ....................... ..................... 4

UNLEVERED COMPANY: ................................ ............................... ...................... ................................ ...... 7

BETAS OF LEVERED AND UNLEVERED BY SECTOR: .......................... ................................ ...................... .... 7

CONCLUSION: ........................................................................................................................................ 12


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INTRODUCTION:

Unlevered Beta: A type of metric that compares the risk of an unlevered company to the risk of

the market. The unlevered beta is the beta of a company without any debt. Unlevering a beta

removes the financial effects from leverage. The formula to calculate a company's unlevered beta

is:

Where:

BL is the firm's beta with leverage. .

Tc is the corporate tax rate. .

D/E is the company's debt/equity ratio.

Levered Beta: Levered beta is the beta that reflects a capital structure that does include debt.

The term often refers to firms that have a large percentage of debt relative to equity when

compared against peers in the same industry. Many financiers believe that the optimum capital

structure requires some level of borrowing, though the exact percentage will vary depending on

the industry and management's preferences. However, companies that do not have debts on their

balance sheets tend to survive better in a recession.

HOWTO CALCULATE LEVERED BETA:

Robert Hamada combined the capital asset pricing model and the Modigliani and Miller

capital structure theories to create the Hamada equation. There are two types of risk for a firm

financial and business. The business risk relates to the unlevered beta for the firm; the financial

risk refers to the levered beta. An unlevered beta assumes zero debt. The Hamada equation

illustrates that when a firm increases its debt, the financial leverage also increases the firm's risk

and, in turn, its beta. Levered beta can be calculated based on the unlevered beta, tax rate, and

debt-to-equity ratio.


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STEPSTO CALCULATE:

1. Gather the following information about the company - Unlevered beta, tax rate and the

debt-to-equity ratio. The tax rate varies, based on the location and size of the firm. You

must estimate the tax rate.

2. Multiply the debt-to-equity ratio by 1 minus the tax rate, and add 1 to this amount. For

example, with a tax rate of 26.2 percent, a debt-to-equity ratio of 1.54 and a beta of 0.74,

the resulting value is 2.13652 (1.54 times (1-.40))+1).

3. Multiply the amount in Step 3 by the unlevered beta to get the levered beta. In the

example above, the levered beta would be 1.58 (2.13652 times 0.74).

HOWTO CALCULATEUNLEVERED BETA:

A company's beta is a numerical measure of how closely correlated a company's shares

are to the stock market as a whole. A beta of zero means there is no correlation between the

company's stock and the market; a positive beta means that the company's shares move in the

same direction as the market; and a negative beta means that the company's shares are inversely

correlated to the market. An unlevered beta compares the movement in the shares of a company

without debt to the movement of the market. By removing the effects of debt, an unlevered beta

measures the riskiness of the company's underlying operations. For this reason, unlevered beta is

a popular measure of systemic risk, and it is widely used by investors and corporate managers.

STEPSTO CALCULATE:

y Get the company's levered beta.

y Determine the company's corporate tax rate by dividing the company's tax expense by its

pre-tax income on the income statement. To be conservative, you should use the

company's average tax rate over the past three years.

y Compute the company's debt-to-equity ratio by dividing total debt by stockholders' equity

on the company's balance sheet.

y Calculate the company's unlevered beta according to the following formula:

Bl / [1+ (1-Tc) x (D/E)].


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In this formula, Bl is the levered beta, in Step 1; Tc is the average corporate tax rate that

you computed in Step 2; and D/E is the debt-to-equity ratio you calculated in Step 3. As an

example, suppose that a company has a levered beta of 1.6, an average corporate tax rate of 35

percent and total debt of $100 and stockholders' equity of $200. The company's unlevered beta

would be 1.6 / [1+ (1-0.35) x (100/200)] = 1.2.s

BETA CONCEPT:

In finance, the beta of a stock or portfolio is a number describing the relation of its

returns with that of the financial market as a whole. The beta coefficient is a key parameter in the

capital asset pricing model (CAPM). It measures the part of the asset's statistical variance that

cannot be mitigated by the diversification provided by the portfolio of many risky assets, because

of the correlation of its returns with the returns of the other assets that are in the portfolio. Beta

can be estimated for individual companies using regression analysis against a stock market index

such as, S&P 500 & so on.

It is non-diversifiable risk, its systematic risk, or market risk. Beta is also referred to as

financial elasticity or correlated relative volatility, and can be referred to as a measure of the

sensitivity of the asset's returns to market returns. Measuring beta can give clues to volatility and

liquidity in the market place.

LEVERED COMPANY:

A levered company is a company that uses any debt to help finance its operations. Most

companies are leveraged to some degree, but others take on so much debt they have difficulty

servicing it and may file for bankruptcy. Highly leveraged companies often have more volatile

profits than other companies. Some analysts, however, dispute the idea that leverage affects a

company's performance in any way.

In finance, leverage is a general term for any technique to multiply gains and losses. Common

ways to attain leverage are borrowing money, buying fixed assets and

using derivatives. Important examples are:


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A public corporation may leverage its equity by borrowing money. The more it borrows the

less equity capital it needs, so any profits or losses are shared among a smaller base and are

proportionately larger as a result.

A business entity can leverage its revenue by buying fixed assets. This will increase the

proportion of fixed, as opposed to variable, costs, meaning that a change in revenue will

result in a larger change in operating income.

Hedge funds often leverage their assets by using derivatives.

Levered equity means equity in a company that also uses debt financing. Unlevered equity is

equity financing for an all-equity firm. If you thought that Intel should be more levered, you

could buy shares in Intel partially using your own cash and borrow the amount of money

representing the amount of leverage you believe Intel should have for the percentage of thecompany that you own to buy additional shares in Intel. You will have used leverage to create a

riskier portfolio than owning Intel alone.

A highly leveraged company has most of its capitalization from long and short term debt,

not in share underwriting. With a highly leveraged company, the assets and operations may

suffer from outside influences such as a takeover, or greenmail. To shield against this the long

term debt may be traded for tax-differed or exempt bonds, issued by the government; this is often

done in specific industries to promote growth in those areas.

A company that uses borrowed money to help finance its assets. Leveraged companies often

have more volatile earnings than firms that rely solely on equity financing. This volatility is

offset, however, by the possibility of a higher return to stockholders if the firm is able to earn

more on its assets than the cost of the money used to finance those assets.

In finance, leverage is a general term for any technique to multiply gains and losses. Common

ways to attain leverage are borrowing money, buying fixed assets and

using derivatives. Important examples are:

A public corporation may leverage its equity by borrowing money. The more it borrows the

less equity capital it needs, so any profits or losses are shared among a smaller base and are

proportionately larger as a result.


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A business entity can leverage its revenue by buying fixed assets. This will increase the

proportion of fixed, as opposed to variable, costs, meaning that a change in revenue will

result in a larger change in operating income.

Hedge funds often leverage their assets by using derivatives.

Levered equity means equity in a company that also uses debt financing. Unlevered equity is

equity financing for an all-equity firm. If you thought that Intel should be more levered, you

could buy shares in Intel partially using your own cash and borrow the amount of money

representing the amount of leverage you believe Intel should have for the percentage of the

company that you own to buy additional shares in Intel. You will have used leverage to create a

riskier portfolio than owning Intel alone.

A highly leveraged company has most of its capitalization from long and short term debt,

not in share underwriting. With a highly leveraged company, the assets and operations may

suffer from outside influences such as a takeover, or greenmail. To shield against this the long

term debt may be traded for tax-differed or exempt bonds, issued by the government; this is often

done in specific industries to promote growth in those areas.

A company that uses borrowed money to help finance its assets. Leveraged companies

often have more volatile earnings than firms that rely solely on equity financing. This volatility isoffset, however, by the possibility of a higher return to stockholders if the firm is able to earn

more on its assets than the cost of the money used to finance those assets.

y The use of various financial instruments or borrowed capital, such as margin, to increase the

potential return of an investment.

y The amount of debt used to finance a firm's assets. A firm with significantly more debt than

equity is considered to be highly leveraged.

y Leverage is most commonly used in real estate transactions through the use of mortgages to

purchase a home.

EG : Enron & Satyam


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UNLEVERED COMPANY:

An unlevered company is a company which has no debt.

EG: Infosys

BETASOF LEVERED ANDUNLEVERED BYSECTOR:

The table shows industry average betas, levered and unlevered for US COMPANIES.

Please refer to the section: Variable Definition for further explanations.

Industry Name

Number of

Firms

Average

Beta

Market D/E

RatioUnlevered Beta

Advertising 35 1,23 21,59% 1,03

Aerospace/Defense 67 0,80 30,29% 0,64

Air Transport 46 1,34 48,95% 0,97

Apparel 65 0,76 18,34% 0,67

Auto & Truck 25 1,08 189,97% 0,44

Auto Parts 60 1,06 42,53% 0,80

Bank 499 0,53 22,04% 0,45

Bank (Canadian) 7 0,77 12,74% 0,71

Bank (Foreign) 5 1,36 7,99% 1,27

Bank (Midwest) 38 0,71 25,61% 0,60

Beverage (Alcoholic) 22 0,58 20,17% 0,50

Beverage (Soft Drink) 17 0,41 15,50% 0,37

Biotechnology 90 1,30 4,01% 1,25

Building Materials 49 0,74 27,72% 0,61

Cable TV 21 1,75 53,34% 1,15


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Canadian Energy 11 0,62 17,66% 0,56

Cement & Aggregates 13 0,78 18,46% 0,69

Chemical (Basic) 16 0,91 29,19% 0,73

Chemical (Diversified) 31 0,79 16,85% 0,70

Chemical (Specialty) 92 0,79 23,32% 0,66

Coal 11 0,76 17,63% 0,66

Computer

Software/Svcs 389 1,90 3,40% 1,85

Computers/Peripherals 143 2,06 8,06% 1,92

Diversified Co. 117 0,75 26,67% 0,62

Drug 305 1,30 7,92% 1,21

E-Commerce 52 3,07 6,55% 2,89

Educational Services 38 1,10 2,29% 1,08

Electric Util. (Central) 25 0,76 91,24% 0,46

Electric Utility (East) 31 0,72 81,86% 0,45

Electric Utility (West) 16 0,79 82,23% 0,50

Electrical Equipment 93 1,40 64,93% 0,89

Electronics 179 1,45 16,26% 1,27

Entertainment 88 1,40 23,60% 1,17

Entertainment Tech 31 1,87 5,51% 1,78

Environmental 85 0,69 54,85% 0,46

Financial Svcs. (Div.) 233 0,78 57,41% 0,53

Food Processing 104 0,58 22,03% 0,50

Food Wholesalers 20 0,63 20,06% 0,54


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Foreign Electronics 12 1,12 18,37% 0,99

Foreign Telecom. 21 1,76 19,86% 1,51

Furn/Home Furnishings 38 0,82 15,87% 0,74

Grocery 23 0,78 58,05% 0,55

Healthcare Information 32 1,06 14,62% 0,94

Home Appliance 16 0,76 21,09% 0,65

Homebuilding 34 0,85 46,03% 0,64

Hotel/Gaming 77 0,74 43,13% 0,54

Household Products 30 0,74 13,50% 0,67

Human Resources 28 1,14 8,90% 1,07

Industrial Services 200 0,85 23,33% 0,71

Information Services 33 0,94 8,77% 0,87

Insurance (Life) 43 0,75 7,92% 0,70

Insurance (Prop/Cas.) 78 0,67 3,95% 0,65

Internet 297 2,63 2,23% 2,57

Investment Co. 21 0,64 28,60% 0,50

Investment Co.(Foreign) 17 1,08 0,00% 1,08

Machinery 133 0,77 36,08% 0,60

Manuf. Housing/RV 19 1,00 16,67% 0,88

Maritime 28 0,67 61,87% 0,44

Medical Services 195 0,82 18,18% 0,72

Medical Supplies 262 0,85 5,93% 0,81

Metal Fabricating 38 0,80 12,10% 0,74


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Metals & Mining (Div.) 76 0,99 18,39% 0,85

Natural Gas (Distrib.) 30 0,65 76,59% 0,42

Natural Gas (Div.) 38 0,84 54,76% 0,58

Newspaper 20 0,84 16,32% 0,74

Office Equip/Supplies 28 0,94 31,74% 0,77

Oilfield Svcs/Equip. 93 0,98 20,24% 0,84

Packaging & Container 35 0,80 63,85% 0,53

Paper/Forest Products 39 0,86 65,81% 0,55

Petroleum (Integrated) 34 0,85 14,01% 0,77

Petroleum (Producing) 145 0,62 19,38% 0,54

Pharmacy Services 14 0,78 7,59% 0,74

Power 24 1,56 44,36% 1,11

Precious Metals 61 0,41 7,80% 0,38

Precision Instrument 104 1,52 10,12% 1,40

Publishing 43 0,74 20,09% 0,64

R.E.I.T. 135 0,63 4,19% 0,61

Railroad 18 0,67 42,63% 0,53

Recreation 78 0,93 18,97% 0,81

Restaurant 84 0,69 15,41% 0,61

Retail (Special Lines) 175 1,01 8,98% 0,95

Retail Building Supply 14 0,90 36,97% 0,73

Retail Store 9 0,88 3,92% 0,86

Securities Brokerage 49 0,97 16,75% 0,87

Semiconductor 26 1,32 83,86% 0,80


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Semiconductor Equip 124 2,64 6,18% 2,50

Shoe 16 2,51 8,32% 2,33

Steel (General) 24 0,98 4,90% 0,94

Steel (Integrated) 14 1,26 27,05% 1,03

Telecom. Equipment 120 2,26 3,40% 2,20

Telecom. Services 137 1,32 27,61% 1,06

Thrift 222 0,48 10,51% 0,45

Tire & Rubber 14 1,02 75,25% 0,63

Tobacco 13 0,59 25,13% 0,50

Toiletries/Cosmetics 23 0,72 12,01% 0,66

Trucking 36 0,78 33,47% 0,64

Utility (Foreign) 6 0,85 57,48% 0,58

Water Utility 17 0,60 59,84% 0,43

Wireless Networking 66 2,38 22,92% 1,96

G

rand Total 7091 1,00 26,93% 0,81


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CONCLUSION:

Beta helps us to measure the volatility of the companys market share. For an individual

when he wants to investment in any company, Beta helps him to take the right decision. Levered

company is a company which has financial debt and unlevered company is a company in which

unloading of financial debt takes place. Beta is used as a measure to rate the companies in

Bombay Stock Exchange (BSE) & National Stock Exchange (NSE). If beta = 1 it states that the

companies share goes hand in hand with the market share.

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