ACCOUNTING PROBLEMS NEEDED BY 5/15/12
1. Seattle health Plans currently uses zero-debt financing. Its operating income (EBIT) is $1 million and it pays taxes at a 40% rate. It has $5 million in assets and because it is all-equity financed, $5 million in equity. Suppose the firm is considering replacing half of its equity financing with debt financing bearing an interest rate of a8%.

a. What impact would the new capital structure have on the firm’s net income?
b. What impact would the new capital structure have on total dollar return to investors?
c. What impact would the new capital structure have on the ROE?
d. Redo the analysis, but now assume that the debt financing would cost 15%?
e. Return to the initial 8% interest rate. Now assume that EBIT could be as low as $500,000 (with a probability of 20%) or as high as $1.5 million (with a probability rate of 20%). There remains a 60% chance that EBIT would be $1 million. Redo the analysis for each level of EBIT and find:
f. The expected values for the firms net income?
g. The expected values for the total dollar return?
h. The expected values for ROE?

Repeat the analysis for part a, but now assume that Seattle Health Plans is a not-for-profit corporation and pays no taxes. Compare the results with those obtained in part a.

2. Calculate the after-tax cost of debt for the Wallace Clinic a for-profit healthcare provider, assuming that the coupon rate set on its debt is 11% and its tax rate is:
a. 0 percent
b. 20 percent
c. 40 percent
Show work

3. St. Vincent’s Hospital has a target capital structure of 35% debt and 65% equity. Its cost of equity (fund capital) estimate is 13.5% and its cost of tax-exempt debt estimate is 7%. What is the hospital’s corporate cost of capital?

4. Richmond Clinic has obtained the following estimates for its costs of debt and equity at various capital structures:
Percent Debt After-Tax Cost of Debt Cost of Equity
0% - 16%
20% 6.6% 17%
40% 7.8% 19%
60% 10.2% 22%
80% 14.0% 27%
What is the firm’s optimal capital structure? (calculate its corporate cost of capital at each structure. Note that the data on component costs at alternative capital structure are not reliable in real-world situations).
5. Capitol Healthplans Inc. is evaluating two different methods for providing home health services to its members. Both methods involve contracting out for services and the health outcomes and revenues are not affected by the method chosen. Therefore, the incremental cash flows for the decision are all outflows. Here are the projected flows:
Year Method A Method B
0 ($300,000) ($120,000)
1 ($66,000) ($96,000)
2 ($66,000) ($96,000)
3 ($66,000) ($96,000)
4 ($66,000) ($96,000)
5 ($66,000) ($96,000)
a. What is each alternatives IRR?
b. If the cost of capital for both methods is 9% which method should be chosen and why?
6. Great Lakes Clinic has been asked to provide exclusive healthcare services for next year’s World Exposition. Although flattered by the request, the clinic’s managers want to conduct a financial analysis of the project. There will be an up-front cost of $160,000 to get the clinic in operation. Then a net cash inflow of $1 million is expected from operations in each of the two years of the exposition. However, the clinic has to pay the organizers of the exposition a fee for the marketing value of the opportunity. This fee, which must be paid at the end of the second year is $2 million.
a. What are the cash flows associated with the project?
b. What is the projects IRR?
c. Assuming a project cost of capital of 10% what is the projects NPV?
d. What is the projects MIRR?
e. SHOW WORK

7. Assume that you are the chief financial officer at Porter Memorial Hospital. The CEO has asked you to analyze two proposed capital investments – Project X and Project Y. Each project requires a net investment outlay of $10,000 and the cost of capital for each project is 12%. The project’s expected net cash flows are as follows:
Year Project X Project Y
0 ($10,000) ($10,000)
1 $6,500 $3,000
2 $3,000 $3,000
3 $3,000 $3,000
4 $1,000 $3,000
a. Calculate each project’s payback period?
b. Calculate net present value (NPV)?
c. Calculate internal rate of return (IRR)?
d. Which project (or projects is financially acceptable?
e. Explain your answer.

8. The director of capital budgeting for Big Sky Health Systems Inc. has estimated the following cash flows in thousands of dollars for a proposed new service:
Year Expected Net Cash Flow
0 ($100)
1 $70
2 $50
3 $20
The project’s cost of capital is 10%.
a. What is the project’s payback period?
b. What is the project’s NPV?
c. What is the project’s IRR?
d. What is the project’s MIRR?

9. The managers of Merton Medical Clinic are analyzing a proposed project. The project’s most likely NPV is $120,000 but as evidenced by the following NPV distribution there is considerable risk involved:
Probability NPV
0.05 ($700,000)
0.20 ($250,000)
0.50 $120,000
0.20 $200,000
0.05 $300,000
a. What are the project’s expected NPV and standard deviation of NPV?
b. Should the base case analysis use the most likely NPV or the expected NPV?
c. Explain your answer.
10. Heywood Diagnostic Enterprises is evaluating a project with the following net cash flows and probabilities:
Year Prob = 0.2 Prb =0.6 Prob =0.2
0 ($100,000) ($100,000) ($100,000)
1 $20,000 $30,000 $40,000
2 $20,000 $30,000 $40,000
3 $20,000 $30,000 $40,000
4 $20,000 $30,000 $40,000
5 $30,000 $40,000 $50,000
The Year 5 values include salvage value. Heywood’s corporate cost of capital is 10%
a. What is the project’s expected (i.e base case) NPV assuming average risk? (the base case net cash flows are the expected cash flows in each year)
b. What are the project’s most likely worst case NPV?
c. What is the project’s most likely best case NPV?
d. What is the project’s expected NPV on the basis of the scenario analysis?
e. What is the project’s standard deviation of NPV?
f. Assume that Heywood’s managers judge the project to have lower-than-average risk. The company’s policy is to adjust the corporate cost of capital up or down by 3 % points to account for differential risk. Is the project financially attractive? Why?

11.California Health Center, a for-profit hospital is evaluating the purchase of new diagnostic equipment. The equipment which costs $600,000 has an expeSccted life of five years and an estimated pretax salvage value of $200,000 at that time. The equipment is expected to be used 15 times a day for 250 days a year for each year of the project’s life. On average each procedure is expected to generate $90 in collections which is net bad debt losses and contractual allowances in its first year of use. Thus net revenues for Year 1 are estimated at 15x 250 x $80 = $300,000.
a. Perform a sensitivity analysis to see how NPV is affected by changes in number of procedures per day, average collection amount and salvage value.
b. Conduct a scenario analysis. Suppose that the hospital’s staff concluded that the three most uncertain variables were number of procedures per day, average collection amount and the equipment’s salvage value.
The following data were developed:
Scenario Probability # of procedure Average collection equip. salvage value
Worst 0.25 10 $60 $100,000
Most likely 0.50 15 $80 $200,000
Best 0.25 20 $100 $300,000
c. Assume that California Health Center’s average project has a coefficient of variation of NPV in the range of 1.0-2.0. The coefficient of variation is defined as the standard deviation of NPV divided by the expected NPV. The hospital adjusts for risk by adding or subtracting 3 % points to its 10% corporate cost of capital. After adjusting for differential risk is the project still profitable?
d. What type of risk was measured and accounted for in parts b and c?
e. Should this be of concern to the hospital’s managers?
12. The managers of United Medtronics are evaluating the following four projects for the coming budget period. The firm’s corporate cost of capital is 14%
Project Cost IRR
A $15,000 17%
B $15,000 16%
C $12,000 15%
D $20,000 13%
a. What is the firm’s optimal capital budget?
b. Suppose Medtronics managers want to consider differential risk in the capital budgeting process. Project A has average risk, B has below-average risk, C has above-average risk and D has average risk. What are the firm’s optimal capital budget when differential risk is considered? (The firm’s managers lower the IRR of high-risk projects by 3% points and raise the IRR of low-risk projects by the same amount).

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Please xxxxxxxx attached xxxxx xxx let xx xxxx xx xxx need xxxxxxx assistance or any xxxxxxxxxxxxxxxxxxx

file1.1_13.213.3__13.4.xls preview (282 words)

xxxxxx

xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx

xxxx	xxx in xxxxxxxx
x	Zero	xx xx
EBIT	x	1
less xxxxxxxx	x	0.2
EBT	x	0.8
less xxx	xxx	0.32
xxx xxxxxx	0.6	xxxx
xxxxxx	x	xxx
Return xx investor in xxxxxx	0.6	0.48
xxx	xxxxx	xxxxx
The xxx income and return xx investors xx dollar has gone down but xxx return xx investment xxx xxxx up xxx to xxxx financing xx xxx
investment in xxxxxx has decreased.
x
a	Zero	AT 8%
EBIT	1	1
less interest	0	0.375
xxx	1	xxxxx
less xxx	0.4	0.25
Net xxxxxx	xxx	0.375
xxxxxx	5	2.5
xxxxxx to investor xx dollar	0.6	0.375
ROI	12.0%	xxxxx
xxx xxxxxx xx the same xx xx a but xxx xxxxxx xx lower xx xxx xxxx 8%.
c
xx 8%
xxxx	x	xxx	0.5
xxxx interest	0.2	xxx	0.2
EBT	xxx	xxx	xxx
xxxx xxx	0.32	0.52	xxxx
xxx income	0.48	0.78	xxxx
xxxxxx	xxx	2.5	2.5
xxxxxx to investor xx dollar	0.48	xxxx	0.18
xxx	xxxxx	31.2%	7.2%
The debt financing is xxxxxxxxxx xxx xx tax xxxxxx xx xxxxxxxx xxxxx paid, xxx at xxx xxxx xxxx xxx above xxxxxxxx xxxx xxxx xxx
xxxxx of EBIT xx also

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Capitol xxxxxx Plans, xxxx

xxxxxxxxxxxxxxxxxxxxxx

xxxxxxx Health xxxxxx Inc. is evaluating xxx xxxxxxxxx xxxxxxx xxx providing home xxxxxx xxxxxxxx to xxx
xxxxxxxx xxxx methods involve xxxxxxxxxxx out for services, xxx xxx health xxxxxxxx xxx revenues are
not affected by the method xxxxxxx Therefore, xxx xxxxxxxxxxx cash flows xxx the decision are xxx xxxxxxxxx
Here xxx the projected xxxxxx
xxxx	xxxxxx x	xxxxxx B
x	-$300,000	-$120,000
x	-$66,000	xxxxxxxx
x	-$66,000	xxxxxxxx
3	xxxxxxxx	-$96,000
x	xxxxxxxx	xxxxxxxx
x	xxxxxxxx	-$96,000
a. xxxx xx xxxx alternative's IRR?
xx If the xxxx of capital xxx xxxx methods xx 9 xxxxxxxx xxxxx method should be xxxxxxx Why?
xxxxxx
The IRR cannot xx calculated xxxxx there are xxxx xxxxxxxx values (cash xxxxxxxxxx xxx xx the xxxxxxxxxxx xxxx xxxx
xxxx make xxx xxxx xxxxxxx equal xx xxx xxxxxxx investment or xxxx xxxxxxxxx xxx xx xxxx xxxxx is xxxxxxxxx in xxxx case, tehre are xx cash xxxxxxx so, xxx xxxxxx xx calculated.
xxxx flows xx

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CHAPTER xx (4 problems)

14.3 Capitol Healthplans, Inc., is evaluating xxx different xxxxxxx for pro​viding xxxx health xxxxxxxx xx xxx xxxxxxxx Both methods xxxxxxx contracting xxx xxx xxxxxxxxx and the xxxxxx xxxxxxxx xxx revenues are xxx xxxxxxxx by the xxxxxx chosen. xxxxxxxxxx the incremental xxxx flows xxx xxx decision xxx xxx xxxxxxxxx xxxx are xxx xxxxxxxxx xxxxxx

xxxxxxxxxxx A Method B

xxxxxxxxxxxxxxxxxxxxxxx

(66,000) (96,000)

xxxxxxxxxxxxxxxxx

(66,000) (96,000)

xxxxxxxxxxxxxxxxxx

xxxxxxxxxxxxxxxxx

a. What is xxxx xxxxxxxxxxxxx IRR?

b. If the xxxx xx capital for xxxx xxxxxxx is 9 xxxxxxxx which xxxxxxxxxxxxxxx xx xxxxxxx Why?

xxxxxx file xx xxxxxxxxx

xxxx Great Lakes Clinic xxx xxxx xxxxx xx xxxxxxx exclusive healthcare services for xxxx xxxxxx World xxxxxxxxxxx Although flattered by the xxxxxxxx the xxxxxxxx xxxxxxxx want to conduct a xxxxxxxxx xxxxxxxx of the project. There xxxx be xx up-front xxxx xx xxxxxxxx xx get the xxxxxx xx operation. xxxxx x xxx cash xxxxxx xx

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xxx income (before debt) xxx income xxxxxx xxxxx Impact xxxxxx xxxx xxx xxxxxx xxxxxxxxxxxxxxxxxxxxx 600000 xxxxxx xxxxxxxxx by $120000 (b) ROI xxxxxxx to investors)=net xxxxxxxxxxxx xxxxxxxxxxx 12.0% xxxxx decreases xx net will go xxxx resulting in xxx ROI xx ROE=Net income/Equity xxxxx xxxxx xxx increase xx xxx xxxxxxxx DEBT COST 15% Net Income xxxxxxxxxxxxxxxxxxxxx xxxxxx xxxxxx Decreases xxx (return xx xxxxxxxxxxxxxx xxxxxxxxxxxx xxxxxxxxxxx xxxxx 7.5% Decreases ROE=Net income/Equity 12.0% xxxxx Increase e), f, x When xxxx xx $5,00000 xxx xxxxxx ==EBIT-interest-taxes xxxxxx 180000 xxx (return to investors)=net income/Total xxxxxxxxxxx xxxx xxxx xxxxxxx income/Equity xxxx xxxx xxxx xxxx xx xxxxxxxxx xxx Income ==EBIT-interest-taxes 900000 xxxxxx xxx xxxxxxx to investors)=net xxxxxxxxxxxx xxxxxxxxxxx 18.0% 15.6% ROE=Net income/Equity xxxxx xxxxx When xxxx is $1000000 Net xxxxxx ==EBIT-interest-taxes xxxxxx xxxxxx xxx (return to investors)=net income/Total investments 12.0% 9.60% ROE=Net xxxxxxxxxxxxx 12.0% xxxxx h) xx xxxxxxx xxxxxx xxxxx xx a not-for-profit corporation xxxx xx taxes x Net xxxxxx xxxxxxxxxxxxxxx 1000000 800000 ROI xxxxxxx xx xxxxxxxxxxxxxx xxxxxxxxxxxx investments xxxxx 16.0% ROE=Net income/Equity xxxxx xxxxx While comparing with xxxxxx from (a) we

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