Question

A relatively small medical group practice is trying to estimate its corporate cost of capital. The practice is 100 percent equity financed. The rate of return on 20-year Treasury bonds is currently 6 percent, and the expected rate of return on the market is 12 percent. A large practice management firm has a beta coefficient of 0.9. Market research indicates that the cost of equity for very small firms is approximately 4 percentage points higher than the cost of equity for large firms. Moreover, the investors in the small group practice face liquidity risk and thus determine that a liquidity premium of 2 percentage points is appropriate.

a. What is the best estimate of the firm's corporate cost of capital?

b. How would your estimate of the corporate cost of capital change if the success of the medical group practice was highly dependent on the reputation of a single physician in the group?

PLEASE SHOW ALL WORK. THANK YOU!

Answer #1

a). Cost of equity for the large practice management firm = risk-free rate + beta*(market return - risk-free rate)

= 6% + 0.9*(12%-6%) = 11.40%

Cost of equity for small practice firms is 4% higher and investors also require a liquidity premium of 2%, so cost of equity for the small medical group practice will be

11.40% + 4% + 2% = 17.40%

b). If the group's practice is highly dependent on the reputation of a single physician in the group then the risk increases so cost of equity will go up, if that is the case.

Medical Group Inc is a large for-profit practice. Their last
dividend was $2.5 per share and their current stock price is $25.
The dividend is expected to grow at 7% and the company has a beta
coefficient of 1.5. Assume the required market return is 13% and
the risk free rate is 8%.
A) Calculate the cost-of-equity estimate according to the DCF
Method.
B) Calculate the cost-of-equity estimate according to the CAPM
Mehtod.
C) Based on the calculations above, what...

Suppose that firm A is considering entering a business similar
to firm B, a relatively small firm in a single line of business.
Firm A is currently financed with 60% debt and 40% equity. Firm B,
the pure-play firm, has a β of 0.95 and is financed with 40% debt
and 60% equity. Firm B’s marginal tax rate is 30% and firm A’s
marginal tax rate is 25%. Assume the riskless rate is 2% and the
market return is 8%....

Suppose that your
company is launching a new project. To estimate the cost of capital
for the project
you search the market and find
a company that has very similar risk characteristics to the project
as follows:
Market capitalization, MVE =
$100.00
million
Market value of debt, D =
$50.00
million
Cost of debt, Rd =
5.00%
Cost of equity, Re =
15.50%
Corporate tax rate, t =
30%
Calculate the cost of capital
of the project for the following...

The firm is trying to estimate its optimal capital structure.
Right now, the firm has a capital structure that consists of 50%
debt and 50% equity. The risk-free rate is 2.5% and the market risk
premium is 12%. Currently the company's cost of equity, which is
based on the SML. is 18.5% and its tax rate is 21%. What would be
the firms estimated cost of equity if it were to change its capital
structure to 40% debt and 60%...

Jacque Ewing Drilling, Inc., has a beta of 0.95 and is trying to
calculate its cost of equity capital. If the risk-free rate of
return is 6 percent and the expected return on the market is 13
percent, then what is the firm's after-tax cost of equity capital
if the firm's marginal tax rate is 35 percent?
Group of answer choices
19.00%
16.40%
11.60%
12.65%

You want to estimate the Weighted Average Cost of Capital (WACC)
for Costco Corp. The company’s tax rate is 21% and it has the
equity beta of 0.9. Its debt value is $14,727 million and the
equity market value is $138,394 million. Its interest expense is
$150 million. Assume that the risk-free rate is 3% and the market
return is 10%. Based on the information, compute the WACC for
Costco.

Simon Software Co. is trying to estimate its optimal capital
structure. Right now, Simon has a capital structure that consists
of 20 percent debt and 80 percent equity, based on market values.
(Its D/S ratio is 0.25.) The risk-free rate is 6 percent and the
market risk premium, rM – rRF, is 5 percent. Currently the
company’s cost of equity, which is based on the CAPM, is 12 percent
and its tax rate is 40 percent.
Find the new levered...

Droz's Hiking Gear, Inc. has found that its common equity
capital shares have a beta equal to 1.5 while the risk-free return
is 8 percent and the expected return on the market is 14 percent.
It has 7-year semiannual maturity bonds outstanding with a price of
$767.03 that have a coupon rate of 7 percent. The firm is financed
with $120,000,000 of common shares (market value) and $80,000,000
of debt. What is the after-tax weighted average cost of capital for...

2) A small, private firm has approached you for advice on its
capital structure decision. It is in the specialty retailing
business, and it had earnings before interest and taxes last year
of $ 500,000. The book value of equity is $1.5 million, but the
estimated market value is $ 6 million. The firm has $ 1 million in
debt outstanding, and paid an interest expense of $ 80,000 on the
debt last year. (Based upon the interest coverage ratio,...

You have been asked by JJ Corporation to estimate its cost of
capital. It currently has 9.1 million shares, $0.1 par value,
outstanding trading at $10 per share. In addition, it has 50,000
bonds with a coupon rate of 8% trading at 98% of face value of
$1000. The bonds yield a rate of return of 9%. The beta for equity
is 1.2. The risk-free rate is 2.5%. The current market risk premium
is 5%. The tax rate is 25%....

ADVERTISEMENT

Get Answers For Free

Most questions answered within 1 hours.

ADVERTISEMENT

asked 2 minutes ago

asked 9 minutes ago

asked 10 minutes ago

asked 13 minutes ago

asked 13 minutes ago

asked 18 minutes ago

asked 28 minutes ago

asked 34 minutes ago

asked 35 minutes ago

asked 50 minutes ago

asked 51 minutes ago

asked 53 minutes ago