You are a manager for Humana Inc., and you are trying to determine the appropria
ID: 2790124 • 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 Coupon Rate Total Book Value (In millions) Market Price Quote (per bond) $500 million·7.20% due June 15, 2018 $300 million, 6.30% due August 1, 7200% 500 2.240% 6.300% 300 2.420% 018 $400 million, 2.625% due 2.625% 98 3.700% r 1, 2019 3.150% 600 $600 million, 315% due December 1, 2022 $600 million, 3.85% due October 1, 2024 $250 million, 815% due June 15 2.480% 3.850% 600 98 3.230% 8150% 250 148.22 5750% 038 $400 million, 4.625% due December 1, 2042 $750 million, 4.95% due October 4.625% 400 99.65 4.650% 4.950% 750 100 4.950% 2044 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")Explanation / Answer
Unlevered beta = Levered beta / [1 + (1 - tax) D/E]
Market Value of debt, D = Sum of Book Value x Market Price = $3,940.87 million
Market Value of equity, E = No. of shares x Share Price = 146.28 x 255.27 = $37,340.9 million
Levered beta = 0.58 and tax = 35%
=> Unlevered beta = 0.58 / [1 + (1 - 35%) x 3940.87 / 37340.9] = 0.54
Using CAPM,
Unlevered Cost of equity = Rf + beta x (Rm - Rf)
= 2.359% + 0.54 x (8.5% - 2.359%)
= 5.69%
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