29 Jun Question ACCOUNTING PROBLEMS
Question
ACCOUNTING PROBLEMS
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 v
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