* Rachel’Jo Fraser
Dr. James Coon
Health Financial Management
February 25th, 2012
Medical Associates is a large for-profit group practice. Its dividends are expected to grow at a constant rate of 7% per year into the foreseeable future. The firm’s last dividend (D0) was $2, and its current stock price is $23. The firm’s beta coefficient is 1.6; the rate of return on 20-year T-bonds currently is 9%; the expected rate of return is 13%. The firm’s target capital structure calls for 50% debt financing, the interest rate required on the business’s new debt is 10%, and its tax rate is 40%.
Calculate Medical Associates’ cost of equity estimate using the DCF
There are three key ways used to calculate approximately the cost of equity: The Capital Asset Pricing Model (CAPM), the discounted cash flow (DCF) model, and the dept cost plus risk premium model. To calculate the cost of equity all key ways should be used as all methods are mutually exclusive. When approaching the cost of equity with the DCF model there are three input parameters and it uses the dividend valuation model as its basis. Medical Associates is a large for-profit group that is expected to grow at the rate of 7% per year, which is the constant rate E(g) at which the dividend is expected to grow. The constant growth model can be used
E(Re) = D0 x [1+E(g)] + E(g)
= E(D1) + E(g)
The required rate of return on equity, the R(Re) is the rate that stockholders expect to earn on other investments. Investors in Medical Associates can earn this return by either purchasing additional shares of the firm of interest or purchasing stock of similar firms. Medical Associates current stock price is $23 which is the P0. The firms DCF estimate according the DCF model is:
R(Re) = E(D1) + E(g)
= $2.00 x (1+0.07) + 7%
= 9.3% + 7%
Thus, the Medical Associates DCF estimate is...