# 12 ACCOUNTING PROBLEMS PLEASE HELP!

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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xxxxxx xxxxxxxx attached files and xxx xx xxxx xx you need xxxxxxx xxxxxxxxxx xx any clarification,Thank

file1.1_13.213.3__13.4.xls preview (223 words)

# xxxxxx

xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx13.1 | All in millions | ||

x | Zero | xx xx | |

EBIT | x | 1 | |

less interest | 0 | 0.2 | |

EBT | 1 | 0.8 | |

xxxx tax | xxx | 0.32 | |

xxx income | 0.6 | xxxx | |

Equity | 5 | 2.5 | |

Return to xxxxxxxx xx dollar | xxx | xxxx | |

xxx | xxxxx | 19.2% | |

The net xxxxxx and xxxxxx to xxxxxxxxx xx dollar xxx xxxx down xxx the xxxxxx on xxxxxxxxxx has gone xx due xx debt financing xx xxx | |||

investment in xxxxxx xxx decreased. | |||

x | |||

x | Zero | AT xx | |

EBIT | 1 | 1 | |

xxxx xxxxxxxx | x | 0.375 | |

xxx | x | xxxxx | |

less tax | xxx | xxxx | |

xxx income | xxx | xxxxx | |

Equity | x | xxx | |

xxxxxx to investor xx xxxxxx | xxx | xxxxx | |

xxx | 12.0% | xxxxx | |

xxx result is the same as in a xxx the xxxxxx xx lower at xxx than xxx | |||

c | |||

xx 8% | |||

xxxx | 1 | 1.5 | 0.5 |

less xxxxxxxx | 0.2 | 0.2 | xxx |

EBT | xxx | 1.3 | 0.3 |

less tax | 0.32 | xxxx | xxxx |

Net xxxxxx | 0.48 | 0.78 | xxxx |

Equity | 2.5 | 2.5 | xxx |

xxxxxx xx investor xx dollar | 0.48 | 0.78 | xxxx |

xxx | xxxxx | 31.2% | xxxx |

The debt financing xx xxxxxxxxxx due xx xxx shield xx xxxxxxxx being paid, but at xxx xxxx time xxx xxxxx analysis xxxx xxxx the | |||

level of xxxx is also xxxxxxxxx xx xx falls below a certain limit xxx xxxxxxx xx debt xxxxxxxxx can xxx xx xxxxxx which is evident xxxx | |||

xxxxxxxxx in xxx when xxxx xxx xxx millions dollars | |||

x | Zero | AT 8% | |

EBIT | 1 | 1 | |

xxxx xxxxxxxx | 0 | 0.2 | |

xxx | 1 | xxx | |

xxxx xxx | x | 0 | |

xxx income | x | xxx | |

xxxxxx | 5 | 2.5 | |

xxxxxx xx xxxxxxxx xx xxxxxx | 1 | xxx | |

ROI | 20.0% | xxxxx | |

Still xx xx showing the same xxxxxxx the xxxxxx xx xxxxxx and return on xxxxxxxxxx xxx increased in tax free |

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file2.xls preview (826 words)

# xxxxxxx xxxxxx Plans, xxxx

xxxxxxxxxxxxxxxxxxxxxxx xxxxxx xxxxxx Inc. is xxxxxxxxxx xxx different xxxxxxx for providing xxxx health xxxxxxxx to xxx | ||

members. xxxx xxxxxxx xxxxxxx xxxxxxxxxxx out for services, xxx xxx health xxxxxxxx xxx revenues xxx | ||

xxx xxxxxxxx by xxx xxxxxx chosen. xxxxxxxxxx the xxxxxxxxxxx cash flows for xxx decision xxx xxx outflows. | ||

xxxx xxx xxx projected xxxxxx | ||

Year | xxxxxx A | Method B |

0 | -$300,000 | xxxxxxxxx |

1 | xxxxxxxx | -$96,000 |

2 | -$66,000 | -$96,000 |

x | xxxxxxxx | -$96,000 |

4 | -$66,000 | xxxxxxxx |

5 | xxxxxxxx | xxxxxxxx |

xx xxxx is each alternative's IRR? | ||

xx xx the xxxx xx xxxxxxx for xxxx methods xx x percent, xxxxx xxxxxx should be chosen? xxxx | ||

xxxxxx | ||

The xxx cannot xx calculated since xxxxx are only xxxxxxxx xxxxxx xxxxx outflows). IRR is xxx xxxxxxxxxxx xxxx xxxx | ||

xxxx make the cash xxxxxxx equal xx xxx initial xxxxxxxxxx xx cash xxxxxxxxx xxx xx xxxx point xx zero.But, in this xxxxx xxxxx xxx no cash xxxxxxx xxx IRR cannot xx xxxxxxxxxxx | ||

cash flows to |

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**xxxxxxx 14 (4 xxxxxxxxx**

**xxxx** xxxxxxx xxxxxxxxxxxx xxxxx is xxxxxxxxxx two different methods for providing xxxx health services to its xxxxxxxx Both methods xxxxxxx contracting xxx xxx xxxxxxxxx and xxx health xxxxxxxx xxx revenues are xxx affected by the xxxxxx xxxxxxx xxxxxxxxxx xxx incremental cash flows xxx the xxxxxxxx are xxx outflows. Here xxx the projected xxxxxx

xxxxxxxxxxx A Method B

xxxxxxxxxxxxxxxxxxxxxxx

xxxxxxxxxxxxxxxxx

xxxxxxxxxxxxxxxxx

xxxxxxxxxxxxxxxxx

(66,000) (96,000)

(66,000) (96,000)

a. What is each xxxxxxxxxxxxx xxxx

b. If the xxxx of capital for xxxx xxxxxxx xx x percent, which method�should be chosen? xxxx

**xxxxxx file xx xxxxxxxxx**

**xxxx** Great xxxxx xxxxxx xxx xxxx asked xx provide xxxxxxxxx xxxxxxxxxx services for next year's World Exposition. Although flattered by the request, xxx clinic's managers want xx conduct a xxxxxxxxx analysis of the xxxxxxxx xxxxx xxxx xx an up-front xxxx xx xxxxxxxx to xxx the clinic in xxxxxxxxxx Then, a net xxxx xxxxxx xx

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xxx xxxxxx (before xxxxx Net xxxxxx (after debt) xxxxxx Answer 1(a) xxx xxxxxx ==EBIT-interest-taxes xxxxxx 480000 xxxxxxxxx xx $120000 (b) ROI xxxxxxx to xxxxxxxxxxxxxx income/Total xxxxxxxxxxx xxxxx 9.60% decreases xx net will go xxxx xxxxxxxxx xx low xxx c) xxxxxxx xxxxxxxxxxxxx 12.0% xxxxx xxx increase d) NOW ASSUMING DEBT COST 15% Net Income xxxxxxxxxxxxxxxxxxxxx 600000 375000 xxxxxxxxx ROI xxxxxxx to xxxxxxxxxxxxxx income/Total investments 12.0% xxxx xxxxxxxxx xxxxxxx xxxxxxxxxxxxx xxxxx xxxxx xxxxxxxx e), f, g When xxxx xx $5,00000 xxx xxxxxx xxxxxxxxxxxxxxxxxxxxx 300000 180000 xxx (return xx investors)=net income/Total xxxxxxxxxxx 6.0% 3.6% ROE=Net income/Equity 6.0% 7.2% When EBIT is xxxxxxxxx xxx xxxxxx ==EBIT-interest-taxes 900000 780000 xxx (return xx xxxxxxxxxxxxxx xxxxxxxxxxxx xxxxxxxxxxx 18.0% xxxxx xxxxxxx xxxxxxxxxxxxx xxxxx 31.2% When xxxx is xxxxxxxx xxx Income ==EBIT-interest-taxes 600000 xxxxxx xxx (return to xxxxxxxxxxxxxx income/Total xxxxxxxxxxx xxxxx xxxxx xxxxxxx xxxxxxxxxxxxx 12.0% 19.2% h) xx Seattle xxxxxx Plans xx x not-for-profit corporation with no taxes s Net Income xxxxxxxxxxxxxxx 1000000 800000 xxx (return xx xxxxxxxxxxxxxx xxxxxxxxxxxx xxxxxxxxxxx 20.0% xxxxx ROE=Net income/Equity 20.0% xxxxx xxxxx xxxxxxxxx with xxxxxx xxxx xxx xx xxx xxxxxxx see xxxx the taxes reduced the xxxxxxx ROI, xxx heavily xx xx xxxxxxxxx xxx after-tax cost of debt xxx the xxxxxxx Clinic a for-profit xxxxxxxxxx xxxxxxxxx assuming that the coupon rate set on its

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