Team Project 2: Cost of Capital Case 18: Southeastern Home Care (pages 117 through 122)Gapenski, L. C. & Pink, G. H. Cases is healthcare finance (5th ed.). Chicago, IL: HAPAssume that Southeastern Home Care has hired your team as financial consultants to develop the overall corporate cost of capital. You will have to meet with the financial VP and possibly with the president and the full board of directors (including the foundersand the finance professor) to present your findings and answer any questions. This case focuses on the estimation of a businesss cost of capital, including both

corporate and divisional costs. Questions, helpful for this evaluation: 1. What corporate cost of capital (CCC) do you estimate for Southeastern

Homecare?2. The companys financial plan calls for the issue of 30-year bonds to meet long-term debt needs. How valid is an estimate of the cost of debt based on 15-yearbonds? If the estimate is not valid, how might it be adjusted to remove any bias?3. The Board Chair is concerned about factors that affect the corporate cost ofcapital for any business: the level of interest rates, tax rates, capital structurepolicy, and capital investment policy. Does the tax rate, cost of debt, or cost ofequity have the most influence on the CCC of Southeastern Homecare? Why?(Hint: In one graph, show the CCC at +/- 25% and 50% values of the tax rate, costof debt, and cost of equity.)4. Southeastern Homecare has two operating divisions: the Healthcare ServicesDivision and the Information Systems Division.a. Estimate the divisional cost of capital for each of Southeasterns divisions assuming that both divisions have the same optimal (target) capitalstructure. (Hint: Use the CAPM to produce a cost of equity for eachdivision and assume the same corporate tax rate and debt cost for each

division.)b. Southeasterns divisions are each considering two investment opportunities for next year. In which of the projects should Southeasterninvest?c. The divisional presidents have expressed concern that a single cost ofcapital will be applied across the company, regardless of any divisionalrisk differences. What would be the short-term and long-termconsequences of Southeastern using a single cost of capital for bothdivisions?d. Is the divisional cost of capital applicable for all projects within thatdivision? Explain.e. Suppose that one division has a greater capacity for debt financing thanthe other (perhaps due to higher asset value and profitability.) How could

different target capital structures be incorporated into the divisional costsof capital?5. The founders of Southeastern are concerned about the threat posed by homehealth care businesses started by not-for-profit hospitals. Using your answer toQuestion 4a and the data in Table 18.3, estimate the cost of capital for thehomecare division of an average not-for-profit hospital. How much confidence doyou have in the cost of capital estimate? Why?6. One of Southeasterns directors has expressed concern over the difference between the companys target capital structure and the current structure as

reported on the balance sheet.a. What are the book values of Southeasterns long-term debt and equity?What are the current market values of Southeasterns long-term debt and

equity?b. What are Southeasterns target weights, book value weights, and current market value weights of long-term debt and equity (that is, long-term debt/ total capital and common stock / total capital)?c. Which set of weights should be used in the corporate cost of capitalestimate? Why?

7. In your opinion, what are three key learning points from this case?

SOUTHEASTERN COST OF CAPITAL EASTERN HoMECARE wAs founded in 1992 in Miami Florida, as a taxable partnership by Maria Gonzalez, MD mon Garcia, RN; and Ron Sparks, LPT. Its purpose was to provide an home alternative to hospitals and ambulatory care facilities for basic services provided by physicians, registered nurses, lice practical nu and physical For home health services, see t website of the National Association for Home Care & Hospice at www.nahc.org.) The partnership enjoyed enormous success from the very first da of operations. Even its founders were surprised at how easy it was to run the business. The founding coincided with the search bythird-party payers for alternative, and potentially less costly, delivery settings. On the basis of its success in metropolitan Miami, the partner. ship expanded services into Fort Lauderdale and West Palm Beach and then moved into other metropolitan areas in Florida and across the US Southeast. The partners also expanded their services at each location to include occupational, speech, and rehabilitation therapies The founders had sufficient personal resources to startthe company, and they had enough confidence in their business plan to commit most of their own funds to the new years, the external capital requirements brought on by rapid growth exhausted their personal funds, and they were forced to borrow heavily. soon, although they still needed external capital to finance growth, the partnership's ability to borrow at reasonable rates was exhausted. Thus, they incorporated the partnership, and in 2005, they sold CHAP 2014. eproduction without permission is prohibited