Humana Inc.: Managing In A Changing Industry Case Study Solution
Spin-off DCF Valuation
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 with 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 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 revenues of the organizations depends upon 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 $551 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 $2500 million. The spin-off could provide an increase in the value of the company by 354% and a share price of $12 per share. (Brigham, 2016)
Conclusion
Although, the share prices of the firm are declining in the market due to the overall low profitability of the company. But the overall value of the firm could 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 to an increase in the value of the firm which could ultimately increase the value per share and the total shareholders’ wealth.
Exhibits
Exhibit-1: DCF Valuation of Spin-off
| Valuation Before Spin off | |
| Humana | |
| EBITDA | 845 |
| Depreciation and Amortization | 256 |
| EBIT | 589 |
| Tax Rate | 36% |
| NOPAT | 377 |
| Add: Depreciation and Amortization | 256 |
| Less: Capital Expenditures | 586 |
| Free Cash Flow | 47 |
| WACC | 8.74% |
| Growth Rate (Inflation Rate) | 3% |
| Present Value (Perpetuity Basis) | $551 |
| Valuation After Spin off | |||
| Hospitals | Health Plans | Humana | |
| EBITDA | 904 | 100 | 845 |
| Depreciation and Amortization | 210 | 26 | 256 |
| EBIT | 694 | 74 | 589 |
| Tax Rate | 36% | 36% | 36% |
| NOPAT | 444 | 47 | 377 |
| Add: Depreciation and Amortization | 210 | 26 | 256 |
| Less: Capital Expenditures | 396 | 113 | 586 |
| Free Cash Flow | 258 | -40 | 47 |
| WACC | 8.99% | 8.99% | 8.74% |
| Growth Rate (Inflation Rate) | 3% | 3% | 3% |
| Present Value (Perpetuity Basis) | 2955 | -455 | 551 |
| Total Value of Each Segment | $ 2,500 | ||
Exhibit-2: Balance Sheet after Spin-off
| Balance Sheet | ||
| (in millions except per share data) | ||
| Hospitals | Health Plans | |
| Assets: | ||
| Assets | 2239 | 445 |
| Total Assets | 2239 | 445 |
| Liabilities and Equity: | ||
| Liabilities | 704 | 142 |
| Equity | 1535 | 303 |
| Total Liabilities and Equity | 2239 | 445 |
| No. of Shares Outstanding | 132 | 26 |
| Value Per Share | 12 | 12 |
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