50
52
54
57
60
45
46
47
48
49
3
3
4
4
4
1.5
1.5
2
2
2.5
0.5
1.5
1
3
4.5
1
1
1
1
1
Interest
Year 1
Year 2
Year 3
Year 4
Year 5
Net revenues
Cash expenses
Depreciation
Net profit
Estimated retentions
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.
50
52
54
57
60
45
46
47
48
49
3
3
4
4
4
1.5
1.5
2
2
2.5
0.5
1.5
1
3
4.5
1
1
1
1
1
Interest
Year 1
Year 2
Year 3
Year 4
Year 5
Net revenues
Cash expenses
Depreciation
Net profit
Estimated retentions
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.
a. What is the equity value of the HMO using the Free Operating Cash Flow (FCOF) method?
b. Suppose that it was not necessary to retain any of the operating income in the business. What impact
would this change have on the equity value according to the FOCF method?
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