Problem 2 UNDERSTANDING HEALTHCARE FINANCIAL MANAGEMENT Net revenues Cash expenses Depreciation Interest Net profit Estimated retentions ANSWER Assume that you have been asked to place a value on the fund capital (equity) of BestHealth, a not-for-profit HMO. Its projected profit and loss statements and retention requirements are shown below (in millions): 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. b. Suppose that it was not necessary to retain any of the operating income in the business. What impact PROBLEM 2 Chapter 16 — Business Valuation, Mergers, and Acquisitions would this change have on the equity value according to the FOCF method? Year 1 Year 2 Year 3 Year 4 Year 5 a. What is the equity value of the HMO using the Free Operating Cash Flow (FCOF) method? $50.00 $52.00 $54.00 $57.00 $60.00 $45.00 $46.00 $47.00 $48.00 $49.00 $3.00 $3.00 $4.00 $4.00 $4.00 $1.50 $1.50 $2.00 $2.00 $2.50 $0.50 $1.50 $1.00 $3.00 $4.50 $1.00 $1.00 $1.00 $1.00 $1.00 Problem 2 UNDERSTANDING HEALTHCARE FINANCIAL MANAGEMENT Net revenues Cash expenses Depreciation Interest Net profit Estimated retentions ANSWER Assume that you have been asked to place a value on the fund capital (equity) of BestHealth, a not-for-profit HMO. Its projected profit and loss statements and retention requirements are shown below (in millions): 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. b….
