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a. What is the equity value of the HMO using the Free Operating Cash Flow (FCOF) method?

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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?

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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….

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