Humana Inc., Case Solution
Consideration of Spin-off strategy at Humana would lead towards a substantial change in the financial structures of the organization. The spin-off strategy requires the company to separate its business segments. The new financial structures would include the total assets acquired by both of the segments after the spin-off. The total value of the firm calculated through DCF valuation i.e. $3643, can be distributed among the both segments, on the basis of the ratio of their total assets in the firm. The ratio of Hospitals in the total assets equals to 83% with Health plans having a ratio of 17%. On the basis of this ratio the total value of the firm after spin-off, the corporate assets and debt and the number of outstanding shares are distributed.
The balance sheet given in the Exhibit 2 shows the assets, liabilities and the equity of each of the business segment separately along with number of outstanding shares and the value per share.
A DCF valuation for one of the most important strategic restructuring option could be conducted to evaluate the change in the value of the firm after the spin-off. The DCF valuation of Spin-off could be conducted on a perpetuity basis,by assuming inflation rate as the growth rate. In this regards, a hurdle rate is calculated for each of the business segment separately and for Humana as whole, by using the given data for 1991. The assumptions for calculating the hurdle rate, are as follows:
- Unlevered Beta is taken as an industry average from hospitals organizations as most of the organization’s revenues depend on its hospital segment.
- Market risk premium is assumed to be 5% on general assumption basis.
- Cost of debt is calculated by using 1991 interest expense and LTD
- Tax Rate is calculated by using 1991 taxes paid and the 1991 EBIT.
On the basis of given data, the WACC for Humana Inc. equals to 8.74% and the WACC for Hospitals and Health Plan business segment equals to 8.99% and 8.99%, respectively. The DCF valuation before spin-off for Humana shows an enterprise value of $814 million, given in the Exhibit 1. However, the DCF valuation for Humana with considering both of the business segments separately shows an enterprise value of $3643 million. The spin-off can provide an increase in the value of the company by 348% and a share price of $19 per share. (Brigham, 2016)
Although, the firm’s share prices are declining in the market due to the overall low profitability of the company,but the company’s overall value can be increased by considering the corporate spin-off strategy and separating the highly profitable Hospital business segment from low profitable Health Plan business segment. It could lead towards an increase in the value of the firm, which could ultimately increase the value per share and the total shareholders’ wealth…………………….
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