You are a manager for Humana Inc., and you are trying to determine the appropria
ID: 2789544 • Letter: Y
Question
You are a manager for Humana Inc., and you are trying to determine the appropriate discount rate to use in valuations of average risk project proposals for the company. You have the following information:
YTM on 10-year Treasury bill: 2.359%
Beta on common stock: 0.58
Expected return on market portfolio: 8.5%
Additionally, you collected the following information from Humana's most recent annual financial disclosure and market prices on current bond issues
Bond issue
Total Book Value
(in millions)
Market Price Quote
(per bond)
$500 million, 7.20% due June 15, 2018
7.200%
500
104
2.240%
$300 million, 6.30% due August 1, 2018
6.300%
300
101
2.420%
$400 million, 2.625% due October 1, 2019
2.625%
400
98
3.700%
$600 million, 3.15% due December 1, 2022
3.150%
600
103.12
2.480%
$600 million, 3.85% due October 1, 2024
3.850%
600
98
3.230%
$250 million, 8.15% due June 15, 2038
8.150%
250
148.22
5.750%
$400 million, 4.625% due December 1, 2042
4.625%
400
99.65
4.650%
$750 million, 4.95% due October 1, 2044
4.950%
750
100
4.950%
The market price for one share of common stock is $255.27, and there are 146.280 million shares outstanding.
Assume Huamana's marginal tax rate is 35%.
You now remember that Humana has plans to gradually change their capital structure over the next few years, making the APV method of valuation more appropriate. You remember that this means you need to first find the value of the unlevered firm.
What is Humana's unlevered cost of equity? Enter your answer as a decimal, rounding to the nearest ten-thousandth. (For example, write "1.23%" as ".0123".)
Bond issue
Coupon RateTotal Book Value
(in millions)
Market Price Quote
(per bond)
YTM$500 million, 7.20% due June 15, 2018
7.200%
500
104
2.240%
$300 million, 6.30% due August 1, 2018
6.300%
300
101
2.420%
$400 million, 2.625% due October 1, 2019
2.625%
400
98
3.700%
$600 million, 3.15% due December 1, 2022
3.150%
600
103.12
2.480%
$600 million, 3.85% due October 1, 2024
3.850%
600
98
3.230%
$250 million, 8.15% due June 15, 2038
8.150%
250
148.22
5.750%
$400 million, 4.625% due December 1, 2042
4.625%
400
99.65
4.650%
$750 million, 4.95% due October 1, 2044
4.950%
750
100
4.950%
Explanation / Answer
Market Value of Debt = 5,000,000 *104 + 3,000,000 *101 + 4,000,000 * 98 + 6,000,000*103.12 + 6,000,000 *98 + 2,500,000 *148.22 + 4,000,000 *99.65 + 7,500,000 *100 = 3,940,870,000
Market Value of Equity = 255.27 * 146,280,000 =37,340,895,600
Debt to Equity = 3,940,870,000/37,340,895,600
Equity beta = levered beta = 0.58
According to Hamada equation
Beta levered = Unlevered beta *(1+(1-Tax)* Debt/Equity)
0.58 = Unlevered beta *(1+(1-0.35)*3,940,870,000/37,340,895,600)
On solving,
Unlevered beta = 0.5427665
Unlevered beta = 0.5428 (Rounded to nearest ten-thousandth)
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.