Leverage Effect On Beta

This question tests whether you understand how capital structure affects risk in valuation. In investment banking interviews, candidates are expected to distinguish between business risk, which comes from the company’s operations, and financial risk, which comes from using debt. Interviewers ask this because beta is used in discount rates and cost of equity calculations, so you need to know how leverage changes the risk borne by equity holders and why that matters when comparing companies with different capital structures.

A strong answer requires explaining the relationship between the company’s operating risk and its financing choices, and how borrowing can make equity returns more volatile. It also checks that you understand why analysts may adjust beta when moving between a comparable company’s capital structure and the target company’s capital structure in intrinsic valuation.