A Short Note on the Hamada Formula
16 Pages Posted: 2 Apr 2007
Date Written: March 26, 2007
Most leading finance textbooks introduce the Hamada formula to adjust the market beta for leverage effects. A debate has recently emerged in the literature (see Fernandez (2004), Cooper and Nyborg (2006a)) about the present value of tax shields (PVTS). The central issue is whether the PVTS can be computed as the present value of the tax savings from interest. The response given to this question directly affects the Hamada formula. We propose, in this short note, a modified Hamada formula can be viewed as a generalization of both the original Hamada formula and the beta adjustment formula obtained under the Miles and Ezzell assumption (1980). Our approach relies on a constant leverage policy in book value assumption, which we believe to be a better representation of firms' behaviour than the previous assumptions used in the literature (either a constant debt in absolute value or a constant leverage in market value).
Keywords: beta, Hamada, cost of capital, leverage
JEL Classification: G31, G32
Suggested Citation: Suggested Citation