Southern Healthcare and BestWell are for$-$profit HMOs that operate in Florida and Georgia. Currently, both are identical in every respect except that Southern is unleveraged while BestWell has $$10$ million of $5$ percent bonds. Both HMOs report an EBIT of $$2$ million and pay corporate tax at a rate of $30$ percent. The cost of equity to Southern is $10$ percent. Assume that all of the MM assumptions hold.

a$.$ What total value would MM estimate for each HMO?

b$.$ What is the value of the equity of each HMO?

c$.$ What is the required rate of return on equity for each HMO?

d$.$ What is the corporate cost of capital for each HMO?

ANSWER

EBIT

Tax rate

Debt outstanding

Cost of debt

Cost of equity

a$.$

VU

TXD

Total value

b$.$

Value of equity

c$.$

$R(Re)$

d$.$

wd

we

$R(Re)$

R$($Rd$)$

$T$

$CCC$