Knowing the difference between levered and unlevered terms is essential, especially when you’re looking at a business’s performance or making investment decisions.
In this blog, you’ll learn:
Let’s dive in.
What is Beta?
Before we dive, let’s first understand what Beta is.
Beta is a number that tells you how much a stock moves compared to the overall market (usually measured against an index like the S&P 500 or Nifty 50).
It tells you how risky a company is compared to the market.
- A beta of 1 means the company moves just like the market
- A beta above 1 means it’s riskier (moves more than the market)
- A beta below 1 means it’s less risky (moves less than the market).
For instance, if a tech stock has a Beta of 2, it’s twice as risky as the market.
It might give higher returns in a bull run, but it could also fall more sharply in a crash.
What Does Levered and Unlevered Beta Mean?
Now, let’s see what Levered Beta is.
Levered Beta shows the company’s risk with debt.
It includes the effect of loans or borrowed money. It’s used when you want to see the real-world risk of investing in the company, including how much debt it’s carrying.
Whereas, Unlevered Beta shows the company’s risk without debt.
It removes the impact of debt, so you can focus only on how risky the business itself is.
Used when comparing companies fairly, regardless of how much debt they have.
Let’s say:
- Levered beta = 1.5
- The company has some debt
- Tax rate = 30%
- Debt/Equity ratio = 0.5
Here’s how to do it:
So, Unlevered Beta = 1.11
That’s the risk of the business alone, without debt.
In short:
- Levered = Debt is involved
- Unlevered = No debt is involved
These two terms are used in cash flow, beta, IRR, etc., to show whether or not debt (like loans and interest) has been factored in.
Levered and Unlevered Free Cash Flows
Cash flow is the money a company brings in from its business activities, like:
- Selling products
- Paying for materials
- Investing in future growth
But not all cash is meant for the same group of people.
Different groups, like debt holders (people who lend money to the company) and equity holders (the company’s owners or shareholders), have different rights to this cash.
That’s why we use different types of cash flow to see what belongs to whom.
When we want to look at the total cash available for both debt and equity holders, we use unlevered free cash flow.
This is the money the company generates before paying any interest or debt.
It’s often called Free Cash Flow to the Firm (FCFF) because both lenders and owners could theoretically benefit from it.
Unlevered free cash flow is not affected by how the company is financed, so it’s useful for comparing different companies, no matter how much debt they have.
On the other hand, levered free cash flow is the cash left after the company has paid off its debt obligations, like interest and mandatory loan payments.
This type of cash flow only shows the money that is truly available for the company’s owners or shareholders.
It’s also known as Free Cash Flow to Equity (FCFE).
If the company borrows money during the period, net borrowings (i.e., new loans minus repayments) are added to the calculation, since the borrowed money can be used by the shareholders.
What’s the difference between levered and unlevered free cash flow?
→ Unlevered free cash flow = cash available to both debt and equity holders
→ Levered free cash flow = cash available to equity holders only
Why Net borrowings are added to FCFE and not FCFF?
This is a tricky and one of the most confusing concepts in Free Cash Flow. But, we will try to explain as below:
- We treat FCFF as unlevered free cash flow. It means that business is assumed to be free from debt and will not use the leverage for financing. Hence, we don’t add net borrowings (i.e., new loans minus repayments) in FCFF
- We treat FCFE as levered cash flow and assume debt and equity as separate forms of capital. So, when a business raises debt, it is added, and when the business pays the debt portion, it is subtracted. So net borrowings (i.e., new loans minus repayments) are added.
What is Levered and Unlevered IRR?
IRR stands for Internal Rate of Return.
It tells you how much return (in percentage terms) you’re making on an investment over time, while also considering the time value of money, meaning money today is worth more than the same amount in the future.
Let’s break it down:
- Unlevered IRR is the return on an investment without including any debt.
It shows how the project or business performs on its own, using only the investor’s money.
- Levered IRR, on the other hand, includes the effect of debt.
It shows the return after the company has borrowed money to finance part of the investment.
Since less money is invested upfront (because of the loan), the return percentage can be higher, but the risk is also higher.
IRR is time-sensitive.
It doesn’t just look at how much money you make, it looks at how fast you make it.
For example, if you invest $100,000 and get $150,000 back:
- In 2 years, the IRR is higher
- In 4 years, the IRR is lower
This is why investors often use IRR to compare options like:
- Real estate
- Private equity
- Stocks
- Mutual funds
- Project Financing
It gives a full picture of how quickly and efficiently their money grows.
If you’re ever unsure about which IRR is being shown in an investment deal, just ask the sponsor or operator.
It’s always better to know how much risk is baked into the numbers.
Conclusion
Understanding the difference between levered and unlevered metrics is essential before making any investment decision.
Whether you’re looking at:
- Levered and unlevered beta
- Levered and unlevered free cash flow
- Levered and unlevered IRR
The core idea remains the same.
Levered metrics include the impact of debt, while unlevered ones do not.
This distinction helps you assess the true risk and return profile of an investment.
When you know how to interpret levered and unlevered metrics, you make more confident and smart decisions, as it gives you a clearer picture of a company’s performance.
We hope the difference between levered and unlevered is now clear.
One includes debt, the other doesn’t.
Simple, but powerful.
