Question about levered and unlevered beta
Levered beta is equal to un-levered beta multiplied by (1+(1-t)D/E), where t represents the tax rate. We are applying a tax shield on debt to reflect the reduction in the debt by t*D(which is the present discounted value of all the tax benefits from interest expense). As a result of the leverage risk that debt poses, levered beta would always be greater than un-levered beta.
What I can't seem to understand here is why we only consider the value of debt i.e. (1-t)*D when considering leverage risk as opposed to considering both the value of debt and the value of interest payments the company makes. If I understand correctly, leverage risk is the risk that a company defaults on both its debt and interest payments so why don't we account for this when going from un-levered to levered beta?
Wdym both? Interest is directly derived from the value of debt so why would you bifurcate it?
I'm not sure I understand. Are you saying I don't have to add back all the interest payments to (1-t)*D?
Why would u have to add interest payments?
I think they should be added to reflect the total amount the debt would cost the company, thereby giving you a better idea of the leverage risk.
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