Levered beta
DCFA company's beta as observed in its share price, reflecting both its business risk and its financial leverage.
Also written: equity beta
Levered beta is what you measure by regressing a company's share returns against the market. It bundles two different things: the risk of the underlying operations, and the amplification of that risk by debt.
Debt makes equity riskier without changing the business at all. Fixed interest payments come first, so whatever is left for shareholders swings more than the operating profit does, and the observed beta rises accordingly.
That is why levered betas cannot be compared or averaged directly across a peer set with different capital structures. Doing so silently mixes business risk with financing decisions, and the average means nothing.
The fix is to unlever each peer to its asset beta, average those, then relever at your target's capital structure. That process is what the Hamada equation formalises.
Worked example
A peer has an observed levered beta of 1.45, debt to equity of 0.60 and a 25% tax rate.
Unlevering: 1.45 divided by one plus 0.75 times 0.60, so 1.45 over 1.45, giving an asset beta of 1.00.
Relevering at your target's 0.30 debt to equity: 1.00 times one plus 0.75 times 0.30, giving a levered beta of 1.225. Same business risk, less financial risk, so a lower beta and a lower cost of equity.