Assume that you have been asked to place a value on the ownership position in Br
ID: 2698996 • Letter: A
Question
Assume that you have been asked to place a value on the ownership position in Briarwood Hospital. Its
projected profit and loss statements and retention requirements are shown below (in millions):
Year 1
Year 2
Year 3
Year 4
Year 5
Net revenues
$225.0
$240.0
$250.0
$260.0
$275.0
Cash expenses
$200.0
$205.0
$210.0
$215.0
$225.0
Depreciation
$11.0
$12.0
$13.0
$14.0
$15.0
Earnings before interest and taxes
$14.0
$23.0
$27.0
$31.0
$35.0
Interest
$8.0
$9.0
$9.0
$10.0
$10.0
Earnings before taxes
$6.0
$14.0
$18.0
$21.0
$25.0
Taxes (40 percent)
$2.4
$5.6
$7.2
$8.4
$10.0
Net profit
$3.6
$8.4
$10.8
$12.6
$15.0
Estimated retentions
$10.0
$10.0
$10.0
$10.0
$10.0
Briarwood's cost of equity is 16 percent, its cost of debt is 10 percent, and its optimal capital structure is
40 percent debt and 60 percent equity. The best estimate for Briarwood's long-term growth rate is 4
percent. Furthermore, the hospital currently has $80 million in debt outstanding.
a. What is the equity value of the hospital using the Free Operating Cash Flow (FOCF) method?
b. Suppose that the expected long-term growth rate was 6 percent. What impact would this change have
on the equity value of the business according to the FOCF method? What if the growth rate were
only 2 percent?
c. What is the equity value of the hospital using the Free Cash Flow to Equityhloders (FCFE) method?
d. Suppose that the expected long-term growth rate was 6 percent. What impact would this change have
on the equity value of the business according to the FCFE method? What if the growth rate were
only 2 percent?
Assume that you have been asked to place a value on the ownership position in Briarwood Hospital. Its
projected profit and loss statements and retention requirements are shown below (in millions):
Year 1
Year 2
Year 3
Year 4
Year 5
Net revenues
$225.0
$240.0
$250.0
$260.0
$275.0
Cash expenses
$200.0
$205.0
$210.0
$215.0
$225.0
Depreciation
$11.0
$12.0
$13.0
$14.0
$15.0
Earnings before interest and taxes
$14.0
$23.0
$27.0
$31.0
$35.0
Interest
$8.0
$9.0
$9.0
$10.0
$10.0
Earnings before taxes
$6.0
$14.0
$18.0
$21.0
$25.0
Taxes (40 percent)
$2.4
$5.6
$7.2
$8.4
$10.0
Net profit
$3.6
$8.4
$10.8
$12.6
$15.0
Estimated retentions
$10.0
$10.0
$10.0
$10.0
$10.0
Briarwood's cost of equity is 16 percent, its cost of debt is 10 percent, and its optimal capital structure is
40 percent debt and 60 percent equity. The best estimate for Briarwood's long-term growth rate is 4
percent. Furthermore, the hospital currently has $80 million in debt outstanding.
a. What is the equity value of the hospital using the Free Operating Cash Flow (FOCF) method?
b. Suppose that the expected long-term growth rate was 6 percent. What impact would this change have
on the equity value of the business according to the FOCF method? What if the growth rate were
only 2 percent?
c. What is the equity value of the hospital using the Free Cash Flow to Equityhloders (FCFE) method?
d. Suppose that the expected long-term growth rate was 6 percent. What impact would this change have
on the equity value of the business according to the FCFE method? What if the growth rate were
only 2 percent?
Explanation / Answer
Answer is $388.864 million. Take discounted cash flows only. The Depreciation, EBIT, EBT, Net Profit and Retentions figures are irrelevant.
Get a present value figure for the first 5 years and then a terminal value for the 4% growth into perpetuity. For each year you have Revenues, less Cash Expenses, Taxes and Interest to get your Net Cash Flow. Then you discount the result by dividing by the blended cost of capital. In year 1 that would be 1.136 , in year 2 that would be 1.136 squared (for 2 years), in year 3 that would be 1.136 cubed, in year 4 it would be 1.36 to the 4th power, in year 5 you get 1.136 to the 5th power.
The weighted cost of capital is 40% at 10% rate of return (multiply them) and 60% times 16% rate of return (multiply them) and then add the results to get your 0.136 or 13.6% return.
Year 1
Revenues 225
Expenses 200
Taxes 2.4
Interest 8
Net Cash Flow 14.6
Divide 14.6 by 1.136 to give 14.6 to give 12.8521
Year 2
Rev 240
Exp 205
Tax 5.6
Int 9
Net Cash Flow 20.4
Divide 20.4 by 1.136 squared to get 15.8079
Year 3
Rev 250
Exp 210
Tax 7.2
Int 9
Cash Flow 23.8
Divide 23.8 by 1.136 cubed to get 16.2346
Year 4
Rev 260
Exp 215
Tax 8.4
Int 10
Cash Flow 26.0
Divide 26.0 by 1.136 to the 4th power to get 15.6121
Year 5
Rev 275
Exp 325
Tax 10
Int 10
Cash Flow 30
Divide 30 by 1.136 to the 5th power.
Terminal Value:
Net cash flows in year 5 into perpetuity divided by the weighted cost of capital of 13.6% less the growth rate of 4%.
30/(.136-.04)=312.5
Add up the year 1 thru year 5 cash flows plus the terminal value and mulitply by the 60% equity piece gives you $388.864