29 Jun Question 1. Seattle health Plans currently uses zer
Question
1. Seattle health Plans currently uses zero-debt financing. Its operating income (EBIT) is $1 million and it pays taxes at a 40% rate. It has $5 million in assets and because it is all-equity financed, $5 million in equity. Suppose the firm is considering replacing half of its equity financing with debt financing bearing an interest rate of a8%.
a. What impact would the new capital structure have on the firm’s net income?
b. What impact would the new capital structure have on total dollar return to investors?
c. What impact would the new capital structure have on the ROE?
d. Redo the analysis, but now assume that the debt financing would cost 15%?
e. Return to the initial 8% interest rate. Now assume that EBIT could be as low as $500,000 (with a probability of 20%) or as high as $1.5 million (with a probability rate of 20%). There remains a 60% chance that EBIT would be $1 million. Redo the analysis for each level of EBIT and find:
f. The expected values for the firms net income?
g. The expected values for the total dollar return?
h. The expected values for ROE?
Repeat the analysis for part a, but now assume that Seattle Health Plans is a not-for-profit corporation and pays no taxes. Compare the results with those obtained in part a.
2. Calculate the after-tax cost of debt for the Wallace Clinic a for-profit healthcare provider, assuming that the coupon rate set on its debt is 11% and its tax rate is:
a. 0 percent
b. 20 percent
c. 40 percent
Show work
3. St. Vincent’s Hospital has a target capital structure of 35% debt and 65% equity. Its cost of equity (fund capital) estimate is 13.5% and its cost of tax-exempt debt estimate is 7%. What is the hospital’s corporate cost of capital?
4. Richmond Clinic has obtained the following estimates for its costs of debt and equity at various capital structures:
Percent Debt After-Tax Cost of Debt Cost of Equity
0% – 16%
20% 6.6% 17%
40% 7.8% 19%
60% 10.2% 22%
80% 14.0% 27%
What is the firm’s optimal capital structure? (calculate its corporate cost of capital at each structure. Note that the data on component costs at alternative capital structure are not reliable in real-world situations).
5. Capitol Healthplans Inc. is evaluating two different methods for providing home health services to its members. Both methods involve contracting out for services and the health outcomes and revenues are not affected by the method chosen. Therefore, the incremental cash flows for the decision are all outflows. Here are the projected flows:
Year Method A Method B
0 ($300,000) ($120,000)
1 ($66,000) ($96,000)
2 ($66,000) ($96,000)
3 ($66,000) ($96,000)
4 ($66,000) ($96,000)
5 ($66,000) ($96,000)
a. What is each alternatives IRR?
b. If the cost of capital for both methods is 9% which method should be chosen and why?
6. Great Lakes Clinic has been asked to provide exclusive healthcare services for next year’s World Exposition. Although flattered by the request, the clinic’s managers want to conduct a financial analysis of the project. There will be an up-front cost of $160,000 to get the clinic in operation. Then a net cash inflow of $1 million is expected from operations in each of the two years of the exposition. However, the clinic has to pay the organizers of the exposition a fee for the marketing value of the opportunity. This fee, which must be paid at the end of the second year is $2 million.
a. What are the cash flows associated with the project?
b. What is the projects IRR?
c. Assuming a project cost of capital of 10% what is the projects NPV?
d. What is the projects MIRR?
e. SHOW WORK
7. Assume that you are the chief financial officer at Porter Memorial Hospital. The CEO has asked you to analyze two proposed capital investments – Project X and Project Y. Each project requires a net investment outlay of $10,000 and the cost of capital for each project is 12%. The project’s expected net cash flows are as follows:
Year Project X Project Y
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