Time Warner, the entertainment conglomerate, has a beta of 1.61. Part of the reason for the high beta is 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 ratio by 10 % each year for the next two years on the beta of the stock.