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5/1/10
Net revenues
Cash expenses
Depreciation
Earnings before interest and taxes
Interest
Earnings before taxes
Taxes (40 percent)
Net profit
Estimated retentions
Year 1
Year 2
Year 3
Year 4
Year 5
$225.0
$240.0
$250.0
$260.0
$275.0
$200.0
$205.0
$210.0
$215.0
$225.0
$11.0
$12.0
$13.0
$14.0
$15.0
$14.0
$23.0
$27.0
$31.0
$35.0
$8.0
$9.0
$9.0
$10.0
$10.0
$6.0
$14.0
$18.0
$21.0
$25.0
$2.4
$5.6
$7.2
$8.4
$10.0
$3.6
$10.0
$8.4
$10.0
$10.8
$10.0
$12.6
$10.0
$15.0
$10.0
Briarwood's cost of equity is 16 percent, its cost of debt is 10 percent, and its optimal capital structure is
40 percent debt and 60 percent equity. The best estimate for Briarwood's long-term growth rate is 4
percent. Furthermore, the hospital currently has $80 million in debt outstanding.
a. What is the equity value of the hospital using the Free Operating Cash Flow (FOCF) method?
b. Suppose that the expected long-term growth rate was 6 percent. What impact would this change have
on the equity value of the business according to the FOCF method? What if the growth rate were
only 2 percent?
c. What is the equity value of the hospital using the Free Cash Flow to Equityhloders (FCFE) method?
d. Suppose that the expected long-term growth rate was 6 percent. What impact would this change have
on the equity value of the business according to the FCFE method? What if the growth rate were
only 2 percent?
ANSWER
Net revenues
Cash expenses
Depreciation
Interest
Net profit
Estimated retentions
Year 1
Year 2
Year 3
Year 4
Year 5
$50.0
$52.0
$54.0
$57.0
$60.0
$45.0
$46.0
$47.0
$48.0
$49.0
$3.0
$3.0
$4.0
$4.0
$4.0
$1.5
$1.5
$2.0
$2.0
$2.5
$0.5
$1.5
$1.0
$3.0
$4.5
$1.0
$1.0
$1.0
$1.0
$1.0
The cost of equity of similar for-profit HMO's is 14 percent, while BestHealth's cost of debt is 5
percent. Its current capital structure is 60 percent debt and 40 percent equity. The best estimate
for BestHealth's long-term growth rate is 5 percent. Furthermore, the HMO currently has
$30 million in debt outstanding.
a. What is the equity value of the HMO using the Free Operating Cash Flow (FOCF) method?
b. Suppose that it was not necessary to retain any of the operating income in the business. What
impact would this change have on the equity value according to the FOCF method?
These cash flows include all acquisition effects. Columbia's cost of equity is 14 percent, its beta is 1.0,
and its cost of debt is 10 percent. The risk-free rate is 8 percent.
a. What discount rate should be used to discount the estimated cash flow? (Hint: Use Columbia's cost of
equity to determine the market risk premium.)
b. What is the dollar value of HCA to Columbia's shareholders?
ANSWER