Southern Homecare: Cost of Capital?

Question: #1100

What specific items of capital should be included in a corporate cost of capital estimate? Should historical (embedded) or new (marginal) values be used? Why?
Estimate of Southern's cost of debt:
1. What is your estimate of Southern’s cost of debt?
2. Should flotation costs be included in the cost of debt calculation? Explain.
3. Should the stated (nominal) cost of debt or the effective annual rate be used? Explain.
4. Any new long-term debt issued by the company will likely have a 30-year maturity. How
  valid is an estimate of the cost of debt based on 15-year bonds? If the estimate is not valid,
  how might it be adjusted to remove any bias?
5. Suppose the company’s outstanding debt had not been recently traded; what other
  methods could be used to estimate the cost of debt?
Cost associated with retained earnings:
1. Why is there a cost associated with retained earnings?
2. What is the company’s estimated cost of equity using the CAPM approach?
3. Why is the T-bond rate used to proxy the risk-free rate rather than the T-bill rate?
4. How do historical betas, adjusted historical betas, and fundamental betas differ?
5. How can the market risk premium be estimated?
Discounted cash flow:
1. Use the discounted cash flow (DCF) method to obtain a cost of equity estimate.
2. The firm, over the last few years, has had a 20 percent average return on equity (ROE) and
  has paid out about 50 percent of its net income as dividends. Under what conditions could
  this information be used to help estimate the Southern's expected future dividend growth
  rate?
Use the debt cost (bond yield) plus risk premium method to estimate the cost of equity.
What is your final estimate for Southern’s cost of equity? Explain your answer.
What is your estimate for Southern’s corporate cost of capital?

Case Palm Hospital Soln.xlsx 15 KB

Solution: #1106

Southern Homecare: Cost of Capital

1. Question : Costco has been successful in part due to its unique approach to staffing. Which of the following statements correctly explains its approach in this area?
Student Answer: Costco promotes employees with in-store experience and sponsors them to take graduate-level business courses.
Costco hires only managers who have worked for its competitors.

Costco holds employees’ jobs while they pursue business school degrees on their own.
Costco hires business school graduates directly out of college.

Question 2. Question : ________ is/are an example of a recession-sensitive industry, while ________ is/are an example of a recession-proof industry.
Student Answer: toiletries; construction

auto parts; air travel

air travel; toiletries

toiletries; auto parts

Question 3. Question : Which of the following expressions most closely captures the essence of a strategic business unit?
Student Answer: “the lifeblood of a company”

“a company within a company”