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%.
1. Calculate Medical Associates’ cost of equity estimate using the DCF method.
2. Calculate the cost of equity estimate using CAPM.
3. On the basis of your answers to #1 & #2, what is your final estimate for the firm’s cost of equity?
4. Calculate the firm’s estimate for corporate cost of capital.
5. Describe the four (4) steps of capital budgeting analysis.
6. Describe how is project risk is incorporated into a capital budgeting analysis.