# What is the equity value of the hmo using the free operating cash

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Problem 2 UNDERSTANDING HEALTHCARE FINANCIAL MANAGEMENT Net revenues Cash expenses Depreciation Interest Net profit Estimated retentions ANSWER Assume that you have been asked to place a value on the fund capital (equity) of BestHealth, a not-for-profit HMO. Its projected profit and loss statements and retention requirements are shown below (in millions): The cost of equity of similar for-profit HMO’s is 14 percent, while BestHealth’s cost of debt is 5 percent. Its current capital structure is 60 percent debt and 40 percent equity. The best estimate for BestHealth’s long-term growth rate is 5 percent. Furthermore, the HMO currently has \$30 million in debt outstanding. b. Suppose that it was not necessary to retain any of the operating income in the business. What impact PROBLEM 2 Chapter 16 — Business Valuation, Mergers, and Acquisitions would this change have on the equity value according to the FOCF method? Year 1 Year 2 Year 3 Year 4 Year 5 a. What is the equity value of the HMO using the Free Operating Cash Flow (FCOF) method? \$50.00 \$52.00 \$54.00 \$57.00 \$60.00 \$45.00 \$46.00 \$47.00 \$48.00 \$49.00 \$3.00 \$3.00 \$4.00 \$4.00 \$4.00 \$1.50 \$1.50 \$2.00 \$2.00 \$2.50 \$0.50 \$1.50 \$1.00 \$3.00 \$4.50 \$1.00 \$1.00 \$1.00 \$1.00 \$1.00 Problem 2 UNDERSTANDING HEALTHCARE FINANCIAL MANAGEMENT Net revenues Cash expenses Depreciation Interest Net profit Estimated retentions ANSWER Assume that you have been asked to place a value on the fund capital (equity) of BestHealth, a not-for-profit HMO. Its projected profit and loss statements and retention requirements are shown below (in millions): The cost of equity of similar for-profit HMO’s is 14 percent, while BestHealth’s cost of debt is 5 percent. Its current capital structure is 60 percent debt and 40 percent equity. The best estimate for BestHealth’s long-term growth rate is 5 percent. Furthermore, the HMO currently has \$30 million in debt outstanding. b….

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