Introduction
Universal Insurance Holding, which is currently headquartered in Florida, US covers properties of several firms and individuals against various risks that are measurable in the insurance industry. It also offers other services that are available in the insurance industry. These services include the underwriting of insurance, dealing with claims, as well as managing risks that are associated with various businesses. Universal Insurance Holding offers its services through various subsidiaries spread throughout the US. One of the leading subsidiaries that deal with writing insurance about homeowners includes Universal Property & Casualty Insurance Company.
This subsidiary is wholly owned by Universal Insurance Holding and has its facilities located in Florida. It also started its operations in various places in the US including South Carolina, Hawaii, and Georgia. Through its emphasis on the interaction between the company’s employees and clients, as well as providing quality services and focusing on homeowners’ insurance policies, the company has managed to instigate strong relationships with over 2,500 agents (Anand 13). The agents have recently helped the company to market its insurance policies to various regions. In addition, the agents help the company to underwrite insurance policies.
Universal Insurance Holdings manages to maintain high-quality services through effective pricing of its insurance products. The competitive planning on its premiums and other services has also enabled the company to earn a competitive advantage in the insurance industry. From the financial report, it is indicated that the largest subsidiary is, Universal Property & Casualty Insurance Company, which recorded about 498,000 insurance policies. Although the company is classified among the companies with small capital growth in the financial sector, financial analysts expect Universal Insurance Holding to outperform the market in the next six months. Analysts claim that it will outperform the market with a risk that is above the average.
Calculating the Company’s WACC
The weighted average cost of capital can be calculated from the balance sheet and income statement information. The main formula that helps in calculating the WACC is given as:
WACC = Ks * Ws + Kd * Wd (1-Tc)
Where:
- Ks is the cost of equity or the rate of return that is expected on equity
- Kd is the cost of debt or the rate of return expected on debt
- Ws is the proportion of the value of equity about the total value of company given as Equity/ (Equity +Debt)
- Wd is the proportion of debt about the total value of the company given as Debt/ (Equity + Debt)
- Tc is the corporate tax
Cost of Equity
Cost of Equity = (next year’s dividends per share/current market value of stock) + growth rate. The present dividend’s value is usually used instead of guessing the next year’s dividend value. The growth rate of dividends is provided by Nasdaq as 10.5%.
Ks = (0.04/4.05) + 10.5% = 10.51%
Cost of debt
Cost of debt = yield to maturity of the outstanding debt in terms of percentage * (1-Tc)
Tc = tax bracket.
From the company’s income statement, the following information can help find the tax rate.
Income before Tax Expense =$33,718,000
Income Tax Expense =$13,609,000
Cost of debt = 10.5% * (1 – $13,609,000/$33,718,000) = 6.26%
The per-share market value of the firm
As indicated by the information given by Nasdaq, the current per-share market value of Universal Insurance Holding is $4.05. It is also calculated according to the formula provided below.
Market Price per Share = Net Income – Preferred Dividends/Number of Shares of Common
The market value of Universal Insurance Holding’s equity
The market value of equity of any firm is the same as the total dollar of outstanding shares of the company. Financial analysts also refer to it as market capitalization. It is normally established by calculating the product of the total number of shares and the current price of the stock. This may perhaps be different from the book value of the company since the book value does not take into consideration the potential of growth of the firm.
The market value of the firm’s equity = total number of outstanding shares * market price of each stock. The information given by Nasdaq indicates that the market capitalization of Universal Insurance Holding is 162.33 million.
It can also be calculated as follows.
Number of outstanding shares = 40081481
The market value of the Universal Insurance Holding’s equity = 40081481* $4.05 =162.33 million
Estimating the firm’s market value of debt
It has always emerged that calculating the cost of debt is challenging. For this reason, it is advised that analysts treat the total debt of a company as a coupon bond. A coupon bond earns the interest income periodically. Various firms offer coupon bonds at a discount price. The coupons that are paid to various bondholders, in this case, would be treated as the interest expense that a firm pays regularly. The required rate of return used in calculating the value of debt of the firm is normally the market required rate of return.
Interest expense
The current value of debt
Maturity period
Estimated value of debt = C [1-(1+i) ^-n /i] + M (1+i) ^-n
F = face value
i = market interest rate
C = coupon payment (periodic interest payment)
N = number of payments
Face value of the debt = $134,673,000
Number of payments =10
Market interest rate = 6.26%
Coupon /Interest expense = $11,218,000
Market Value of Debt =$11,218,000[1-(1.063) ^-10 /0.063] + 134,673,000(1.063) ^ -10
$81,403,000 + $73,105,000
$154,508
Total Value of the Firm
From the above calculations, the values of both debt and equity have been assessed. These values would be used to determine the present value of the firm. They would later be used to determine the weighted average cost of capital.
D =$154,508,000
E =$162,330,000
Total equity and debt = $316,888,000
Ws = Equity/ (Equity +Debt) $162,330,000/$316,888,000=0.527
Wd = Debt/ (Equity + Debt) =$154,508,000 /$316,888,000=0.473
Corporate tax = 40%
WACC = Ks * Ws + Kd * Wd (1-Tc)
WACC = 10.51% * 0.527 + 6.26% * 0.473(1 -0.4)
WACC = 7.3154%
Discounted Cash flows (Net Present Value)
Future Value = Present Value * (1+ rate of return) ^n where n is the number of years.
The firm would treat the weighted average cost of capital as the required internal rate of return for the firm. The firm would require this return at the end of every financial period.
Internal Rate of the Firm= 7.3154%
From the cash flow statement provided by Nasdaq, the information indicates that Universal Insurance Holding had cash flows of $96,040,000 in the year 2011and a negative value of $40,164,000 in the year 2010. Furthermore, the firm had a negative value of $80,556,000 in the year 2009.
($ ‘000’)
Total present value = -$39,845,000
Investment decision
With the internal rate of return, the net present value of cash flows that were experienced in the last three years could be calculated. The total net present value of cash flows for the last three years amounted to a negative value of $39,845,000. Since Nasdaq provided cash flows for only three years, it would be fundamental to rely on these amounts to make various investment decisions. In the first instance, it is apparent that Universal Insurance Holding is improving in terms of its amount of net present value. The net cash flows improved by $49,677,000 from the year 2009 to 2010. The amount improved by $139,144,000 from the year 2010 to the year 2011.
This was a great improvement considering that the company had faced negative cash flows in the years 2009 and 2010. A net present value of $96,040,000 implies that Universal Insurance Holdings is one of the fastest-growing companies in terms of cash flows (Shan 90). Cash flows have been used for a long by various financial analysts to assess the value of a firm. In this view, it could be said that the value of Universal Insurance Holding is increasing at a faster rate in comparison to other firms in the insurance industry (Hubbard 12).
When a keen analysis is done on the data provided by Nasdaq, one can deduce important information relating to the investment. The calculation done in the previous parts indicates that Universal Insurance Holding’s market capital of 162.33 million has the potential of increasing at a faster rate in about 5 years. The company’s share price has increased significantly for the past three years. A dividend of $0.04 and a yield of 10.05% about outstanding shares imply that Universal Insurance Holding has the highest rate of dividend growth among the companies investing in the insurance industry. The ratio of price to earnings of 8.10 indicates that the company is performing well in the market.
It would be advisable for investors to purchase shares belonging to Universal Insurance Holdings given that the company has a beta of 0.75. This indicates that the variation between the rate of market return and that for Universal Insurance Holding is minimal. Therefore, investors who avoid investing in risky investments should choose this as the best company given that its amount of risk is low. The company’s earnings per share can also point out that, although the company is still new in the industry, its rate of growth is expected to increase at a faster rate. Sharp analysts or investors would also find out that Universal Insurance Holding is expanding very fast in the market.
When investing, it is fundamental for the investor to make a comparison of various investment opportunities and determine which investment promises a higher return while ensuring that risks are as low as possible. The analysis sometimes requires a thorough examination of elements associated with types of investments. In this regard, it would be essential to take into consideration coupon rates, period of maturity and other features attached to both corporate bonds and municipal bonds. In this scenario, Beth Anaheim is attempting to consider choosing an investment opportunity. Corporate bonds are commonly subjected to federal taxes while municipal bonds are provided with tax exemptions.
Works Cited
Anand, Steve. Optimizing Corporate Portfolio Management: Aligning Investment Proposals with Organizational Strategy. New York, NY: Wiley, 2007. Print.
Hubbard, Davis. How to Measure Anything: Finding the Value of Intangibles in Business. New York, NY: John Wiley & Sons, 2007. Print.
Shan, McGuin. Project Portfolio Management: Leading the Corporate Vision. Basingstoke: Palgrave Macmillan, 2007. Print.