• Compute each component of the WACC by multiplying the weight, or proportion, of each liability in Exhibit 1 times its rate, then combine all of those components to calculate the WACC. The rates for some liabilities are given in the case. The rate for each category of Net Assets is 10%. The rate for A/P and for Accrued Compensation is 0%

• Use two decimals for each component weight and each component product as well as for the WACC, e.g., 3.24%

EXHIBIT 1

THE DISCOUNT RATE Mr. Klein evaluated each of the proposals using his proposed capital budgeting technique. Since the technique used net present value, Mr. Klein had to determine the appropriate discount rate to use. This presented the problem of deriving the hospital's cost of capital and return on its assets. The hospital's liabilities entailed several different rates of interest. Long-term debt included pay- ments on its municipal bonds averaging 6 percent and fixed mortgage payments at 8 percent. Equity capital, on the other hand, was divided between permanently restricted funds (where do- nors had stipulated that the principal could not be spent) and unrestricted funds (which could be used for any purpose). Mr. Klein believed that the appropriate discount rate should take all of the debt interest rates into account, but he was not sure what rate he should assign to the hospital's net assets (or equity), or whether any rate should be used for equity at all. He had read that some hos- pitals used 10 percent for their equity, but he wondered if the discount rate should be adjusted to reflect the risk and uncertainty associated with each project. Finally, he learned that the hospital was earning a 10 percent average return on its certificates of deposit, and about 5 percent on its cash. THE DECISION Mr. Klein was confident that his capital budgeting technique would be a vast improvement for the hospital. He was optimistic about the prospects of developing a system for that finally had a ra- tional, systematic approach to evaluating capital requests. By including the subjective analyses, he believed it would be possible to quantify some of the hospital's returns that did not always translate into dollars. At the same time, however, he realized that someone would still lose out in the end. Assignment: 1. What are the key elements of GVMC's strategy? 2 Why does the existing canital budgeting system need to be changed? GREEN VALLEY MEDICAL CENTER Exhibit 1. Financial Statements for Most Recent Year ($000) BALANCE SHEET Assets Current Assets Cash and cash equivalents $ 11,725 Accounts receivable (net) 3,038 Inventories 3,365 Prepaid expenses and other current assets 520 $ 18,648 Assets whose uses limited Board designated for funded depreciation (principally certificates of deposit) 3,703 Property plant, and equipment (Less accumulated depreciation) 21,809 Total Assets $ 44,160 Liabilities and Net Assets Current Liabilities Accounts payable and accrued expenses Accrued compensation, payroll taxes and related withholdings Current portion of mortgage $ 5,142 3,163 1,451 $ 9,756 Long-term obligations Municipal bonds (net of unamortized issue discount) Mortgage payable $ 9,300 8,050 17,350 Net Assets Permanently restricted Unrestricted Total Liabilities and Net Assets $ 8,550 8,504 17,054 $ 44,160 OPERATING STATEMENT Net revenues from services to patients $ 37,031 Operating expenses: Salaries and wages Supplies and other expenses Depreciation Interest Excess of operating revenues over expenses Non-operating revenues (Investment income) Change in net assets $18.406 14,970 2,163 1,060 36,599 $ 432 978 $ 1,410 THE DISCOUNT RATE Mr. Klein evaluated each of the proposals using his proposed capital budgeting technique. Since the technique used net present value, Mr. Klein had to determine the appropriate discount rate to use. This presented the problem of deriving the hospital's cost of capital and return on its assets. The hospital's liabilities entailed several different rates of interest. Long-term debt included pay- ments on its municipal bonds averaging 6 percent and fixed mortgage payments at 8 percent. Equity capital, on the other hand, was divided between permanently restricted funds (where do- nors had stipulated that the principal could not be spent) and unrestricted funds (which could be used for any purpose). Mr. Klein believed that the appropriate discount rate should take all of the debt interest rates into account, but he was not sure what rate he should assign to the hospital's net assets (or equity), or whether any rate should be used for equity at all. He had read that some hos- pitals used 10 percent for their equity, but he wondered if the discount rate should be adjusted to reflect the risk and uncertainty associated with each project. Finally, he learned that the hospital was earning a 10 percent average return on its certificates of deposit, and about 5 percent on its cash. THE DECISION Mr. Klein was confident that his capital budgeting technique would be a vast improvement for the hospital. He was optimistic about the prospects of developing a system for that finally had a ra- tional, systematic approach to evaluating capital requests. By including the subjective analyses, he believed it would be possible to quantify some of the hospital's returns that did not always translate into dollars. At the same time, however, he realized that someone would still lose out in the end. Assignment: 1. What are the key elements of GVMC's strategy? 2 Why does the existing canital budgeting system need to be changed? GREEN VALLEY MEDICAL CENTER Exhibit 1. Financial Statements for Most Recent Year ($000) BALANCE SHEET Assets Current Assets Cash and cash equivalents $ 11,725 Accounts receivable (net) 3,038 Inventories 3,365 Prepaid expenses and other current assets 520 $ 18,648 Assets whose uses limited Board designated for funded depreciation (principally certificates of deposit) 3,703 Property plant, and equipment (Less accumulated depreciation) 21,809 Total Assets $ 44,160 Liabilities and Net Assets Current Liabilities Accounts payable and accrued expenses Accrued compensation, payroll taxes and related withholdings Current portion of mortgage $ 5,142 3,163 1,451 $ 9,756 Long-term obligations Municipal bonds (net of unamortized issue discount) Mortgage payable $ 9,300 8,050 17,350 Net Assets Permanently restricted Unrestricted Total Liabilities and Net Assets $ 8,550 8,504 17,054 $ 44,160 OPERATING STATEMENT Net revenues from services to patients $ 37,031 Operating expenses: Salaries and wages Supplies and other expenses Depreciation Interest Excess of operating revenues over expenses Non-operating revenues (Investment income) Change in net assets $18.406 14,970 2,163 1,060 36,599 $ 432 978 $ 1,410