Time Warner Inc., the entertainment conglomerate, had a beta of 1.61 in 1995. Part of the reason for the high beta was the debt left over from the leveraged buyout of Time by Warner in 1989, which amounted to $10 billion in 1995. The market value of equity at Time Warner in 1995 was also $10 billion. The marginal tax rate was 40%.
a. Estimate the unlevered beta for Time Warner.
b. Estimate the effect of reducing the debt/equity ratio by 10% each year for the next two years on the beta of the stock.