Unlever & relever beta
An observed equity beta β_ecarries both business and financial risk. Strip the comparable's leverage to the unlevered (asset) beta β_u, then re-add leverage at your target D/E to get the relevered β_e*. More leverage raises equity beta. A positive debt beta β_d raises the asset beta you back out.
Relevered β_e* at target D/E = 40%1.26
Unlevered (asset) beta β_u 0.97Financial-risk add-on β_e* − β_u +0.29
Rebalancing method
Comparable equity (levered) beta β_e1.40
Comparable D/E60%
Tax rate T25%
Debt beta β_d0.00
Target D/E (relever to)40%
Try this
Unlevering β_e = 1.40 at the comparable's D/E of 60% gives an asset beta of 0.97. Relevering to the target D/E of 40% lifts it to 1.26, an added +0.29 of financial risk.
Hamada assumes a fixed dollar debt level, so the tax shield is as safe as the debt and carries the (1 − T) factor.
Discuss: why must you unlever a comparable's beta before applying it to a target with different leverage, and when is the β_d = 0 shortcut safe?