IRS Form 990 Schedule H mandates that all tax-exempt hospitals provide each year the following information to the government for posting on public websites and potential testing for adequacy to maintain tax-exempt status. The categories and your current estimate of $60 million of community benefit (about 5% of revenue) are as follows: Part I: Charity care and other community benefits (i.e., $50 million)

* Charity care at cost. ($30 mil)

* Unreimbursed costs of Medicaid and other means-tested programs ($10 mil)

* Cost of community health improvement and community benefit operations ($5 mil)

* Health professions education and research ($3 mil)

* Cash and in-kind contributions ($2 mil)

Part II: Community-building activities (i.e., $3 mil)

Part III: Income and bad debt (i.e., $7 mil)

* Estimate of bad debt attributable to patients eligible for charity care ($2 mil)

* Difference between Medicare revenue and higher allowable costs ($4 mil)

* Collection practices ($1 mil)

Assume your key donor is in the 30% marginal tax bracket and has an average long-term return on investment of 12%. Tax-exempt debt is currently yielding 4% for hospitals in your bond rating and you have about half of your net assets financed by debt with the remainder coming from contributions and retained earnings. Hospital funds held in financial assets are yielding 5% return on investment while net operating assets used for patient care have been returning more like 3%. Note that the return on operating assets would be double the reported 3% if community benefits were not subtracted as expenses under generally accepted accounting procedures.

[a] What would you recommend the hospital use as its overall cost of capital and why would this be appropriate? (Note: I am much more interested in your logic and support for your recommendation relative to alternatives than in a specific number.)