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CASE 18 Student Version Copyright 2014 Health Administration Press 6172016 SOUTHEASTERN HOMECARE Cost of Capital This case illustrates the cost of capital estimation for a business

CASE 18   Student Version     Copyright 2014 Health Administration Press
6/17/2016          
    SOUTHEASTERN HOMECARE      
    Cost of Capital          
               
This case illustrates the cost of capital estimation for a business with two divisions that    
operate in diverse business lines.          
               
The spreadsheet calculates the cost of debt based on the yield to maturity and the yield  
to call of debt issues that are currently outstanding. It also calculates the cost of equity on  
the basis of three models: CAPM, DCF, and Debt Cost + Risk Premium.      
               
Students must use judgment when making the final estimates for the costs of debt and equity.  
These estimates must be entered into the lower part of the INPUT DATA section to calculate  
the corporate cost of capital. Divisional costs of capital can be estimated using the same  
part of this spreadsheet, but with the appropriate divisional input data.      
               
The model consists of a complete base case analysis—however, all values in the INPUT DATA  
section of the student version have been replaced with zeros. Thus, students must determine  
the appropriate input values and enter them into the model. These cells are colored red.  
When this is done, any error cells will be corrected and the base case solution will appear.  
Note that the model does not contain any risk analyses, so students will have to create    
their own if required by the case. Furthermore, students must create their own graphics  
(charts) as needed to present their results.          
               
               
INPUT DATA:       KEY OUTPUT:      
               
Cost of Debt Input:       Cost of Debt:      
               
Years to maturity   5   YTM 0.9%    
Annual coupon payment   $0.08   YTC 2.0%    
Current price   $956.31          
Par value   $1,000.00          
Years to call   5          
Call price   $1,057.00          
               
Cost of Equity Input:       Cost of Equity:      
CAPM Approach:            
Beta coefficient 1.4   CAPM 13.4%    
Risk-free rate   5.0%          
Required market return 11.0%          
DCF Approach:            
Stock price   $5.25   DCF 13.6%    
Last dividend paid $0.17          
Constant growth rate 10.0%          
Debt Cost Plus RP Approach:          
Risk premium   4.0%   DC+RP 4.9%    
               
Corporate Cost of Capital Input:       Corporate Cost of Capital:      
 
             
               
               
Tax rate   40.0%   CCC 51.8%    
Weight of debt   35.0%          
Weight of equity   65.0%          
Final cost of debt estimate   30.0%          
Final cost of equity estimate   70.0%          
               



5. The founders of Southeastern are concerned about the threat posed by home health care businesses started by not-for-profit hospitals. Using your answer to Question 4a and the data in Table 18.3, estimate the cost of capital for the homecare division of an average not-for-profit hospital. How much confidence do you have in the cost of capital estimate? Why? 6. One of Southeastern’s directors has expressed concern over the difference between the company’s target capital structure and the current structure as reported on the balance sheet. a. What are the book values of Southeastern’s long-term debt and equity? What are the current market values of Southeastern’s long-term debt and equity? b. What are Southeastern’s target weights, book value weights, and current market value weights of long-term debt and equity (that is, long-term debt / total capital and common stock / total capital)? c. Which set of weights should be used in the corporate cost of capital estimate? Why?

 

Sep 08 2020 Read more Less More

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