4 Finance Questions
1.Consider another uneven ash flow stream:
Year Cash Flow
0 2,000
1 2,000
2 0
3 1,500
4 2,500
5 4,000
a. What is the present (Year 0) value of the cash flow stream if the opportunity cost rate is 10 percent?
b. What is the future (year 5) value of the cash flow stream if the cash flows are invested in an account that pays 10 percent annually?
c. What cash flow today (year 0), in lieu of the 2,000 cash flow, would be needed to accumulate 20,000 at the end of year 5 (assume that the cash flows for years 1 through 5 remain the same)
d. Time value analysis involves either discounting or compounding cash flows. Many healthcare financial management decisions-such as bond refunding, capital investment, and lease versus buy-involve discounting projected future cash flows. What factors much executives consider when choosing a discount rate to apply to forecasted cash flows?
2. Twin Oaks Health Center has a bond issue outstanding with a coupon rate of 7 percent and four years remaining until maturity. The par value of the bond is $1000, and the bond pays interest annually.
a. Determine the current value of the bond if present market conditions justify a 14 percent required rate of return.
B. Now suppose Twin Oaks’ four-year bond had semiannual coupon payments. What would be its currrent value? (Assume a 7 percent semiannual required rate of return. However, the actual rate would be slightly less than 7 percent because a semiannual coupon bond is slightly less risky than an annual coupon bond.)
c. Assume that Twin Oaks’ four year bond had a seminannual coupon but 20 years remaining to maturity. What is the current value under these conditions? (Again, assume a 7 percent semiannual required rate of return, although the actual rate would probably be greater than 7 percent because of increased price risk.)
3.Golden State Home Health, Inc., is a large, California-based for-profit home health agency. Its dividends are expected to grow at a constant rate of 5 percent per year into the foreseeable future. The firm’s last dividend (D0) was $1, and its current stock price is $10. The firm’s beta coefficient is 1.2; the rate of return on 20-year T-Bonds currently is 8 percent; and the expected rate of return on the market, as reported by a large financial service firm, is 14 percent. Golden State’s target capital structure calls for 60 percent debt financing, the interest rate required on its new debt is 9 percent, and the firm’s tax rate is 30 percent.
a. What is the firm’s cost of equity estimate according to the DCF method?
b. What is the cost of equity estimate according to the CAPM?
c. On the basis of your answers to Parts a and b, what would be your final estimate for the firm’s cost of equity?
d. What is your estimate for the firm’s corporate cost of capital?
4.You have been asked by the president and CEO of Kidd Pharmaceuticals to evaluate the proposed acquisition of a new labeling machine for one of the firm’s production lines. The machine’s price is $50,000, and it would cost another $10,000 for transportation and installation. The machine falls into the MACRS three-year class, and hence the tax depreciation allowances are 0.33, 0.45, and 0.15 in Years 1, 2, and 3, respectively. The machine would be sold after three years because the production line is being closed at that time. The best estimate of the machine’s salvage value after three years of use is $20,000. The machine would have no effect on the firm’s sales or revenues, but it is expected to save Kidd $20,000 per year in before-tax operating costs. The firm’s tax rate is 40 percent and its corporate cost of capital is 10 percent.
a. What is the project’s net investment outlay at Year 0?
b. What are the project’s operating cash flows in Years 1, 2, and 3?
c. What are the terminal cash flows at the end of Year 3?
d. If the project has average risk, is it expected to be profitable?
