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| Assume that you have been asked to place a value on the ownership position in Briarwood Hospital. Its | ||||||||||
| projected profit and loss statements and retention requirements are shown below (in millions): | ||||||||||
| Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | ||||||
| Net revenues | $225.0 | $240.0 | $250.0 | $260.0 | $275.0 | |||||
| Cash expenses | $200.0 | $205.0 | $210.0 | $215.0 | $225.0 | |||||
| Depreciation | $11.0 | $12.0 | $13.0 | $14.0 | $15.0 | |||||
| Earnings before interest and taxes | $14.0 | $23.0 | $27.0 | $31.0 | $35.0 | |||||
| Interest | $8.0 | $9.0 | $9.0 | $10.0 | $10.0 | |||||
| Earnings before taxes | $6.0 | $14.0 | $18.0 | $21.0 | $25.0 | |||||
| Taxes (40 percent) | $2.4 | $5.6 | $7.2 | $8.4 | $10.0 | |||||
| Net profit | $3.6 | $8.4 | $10.8 | $12.6 | $15.0 | |||||
| Estimated retentions | $10.0 | $10.0 | $10.0 | $10.0 | $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? |
|
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