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##### POTOMAC H EALTH CARE 15 STOCK Porol,lec Hearruca...

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POTOMAC H EALTH CARE 15 STOCK Porol,lec Hearrucanu is an investor-owned hospital chain that owns and operates nine hospitals in Maryland, Virginia, and the District of Columbia. Marcia Long, a recent graduate of a prominent health services administration program, has just been hired by Washington Medical Center, Potomac's iargest hospital. Like all new management personnel, Marcia must undergo three months of intensive indoctrination at the system level before joining the hospital. In Case r4, Potomac Healthcare (A), Marcia conducted an analysis of the firm's bonds and presented her findings to the company's executive committee. Potomac's chief financial officer, Hugo Welsh, was very impressed with the quality of Marcia's presentation. Furthermore, the other members of the committee stated that they learned a great deal about debt financing from Marcia's presentation and that they would like to see a similar presentation on equity financing. Because Marcia would be leaving corporate headquarters to start her hospital assignment in less than four weeks, Hugo immediately assigned her the task of analyzing the firmt equity situation and preparing another presentation for the executive committee. Marcia began by reexaminingthe firmt annual reportto getsome basic data. Then, she searched the Wcl/ Streetlaumal,Value Line, andother potential sources of financial data to obtain some market data as well as analysts'forecasts for the firm. Thble r5.r contains the information that Marcia developed. (For information on thousands of stocks, including beta estimates, see the Yahoo finance web page at http:/ifinance,yahoo .com. To go to healthcare stocks, click on Healthcare, which leads to a (B) VALUA TION t07 r08 Cases in Healthcare Finance TABLE 15.1 Potomac Healthcare: Selected Stock Data Historical Data: Year Earnings per Share Dividends per Share 2000 2001 2002 2003 2004 2005 s1 .14 1.32 1.54 1.56 1.80 2.00 s0.21 0.32 0.35 0.36 0.39 0.48 $8.00 10.0o/o 4.0% Assumed Current (January 1, 2006) Data Current stock price Estimated dividend growth rates: Next 5 years Long-term steady state Market data: Yield on long-term Treasury bonds s.Ook Merrill Lynch estimate of market returns 11.0o/o Value Line beta coefficient 1.2 listing of four related industries. Click on one of the industries to obtain a listing of the companies in that industry. Finally, click on one of the company names to obtain key information on that stock.) As before, Hugo did not want Marcia to go off on a tangent, so he provided her with a list of questions to answer. Also as before, Marcia welcomed the challenge of working on a task that was traditionally assigned to finance MBAs, rather than to graduaies of health services administration programs. Put yourself in Marcia's shoes and see how you would fare if assigned this task and needed to answer the following questions: L a. What are Potomac's historical earnings and dividend growih rates over the entire 2ooo--zoo5 period? (Hint: Use zooo data for the present value, Potomac Healthcare (B) zoo5 data for the future vahrc, and r as the number of periods.) b. What are the average annual compounded growth rates? (Hint: Use zooo data for the present value, zoo5 data for future value, and 5 as the number of periods.) c. Which rate (overall or annual) better expresses the concept of growth? a. What was the firrn's payout ratio in zoo5? (Hint: The payout ratio is the percentage of earnings paid out to stockholders as dividends.) b. What was Potomac's average payout over the past six years? c. If the payout ratio of an average investor-owned hospital company were about 5o percent, is Potomac's payout about average, below average, or above averuge? What is the primary factor that influences a business's payout ratio? a, What is the Capital Asset Pricing ModelZ What is the Security Market Line (SML)? b. Graph the SML using the data presented in Thble r5.r. c. What would happen to the SML if investors' risk aversion increased and the required rate of return on ihe market rose to rz percent? d. What would happen to the SML if inflation expectations increased by r percentage point? (Hint: Investors would add r percentage point to their required rates of return on all assets, including riskfree assets,) e. Return to the base case data in Part b of this question. According to the SML, what is the required rate of return on Potomac's stock? Plot that point on your SML graph. For now, disregard the dividend growth rates given in Table r5.r, Assume that analysts estimated that Potomac would have a long-term (constant) dividend growth rate of 5.o percent. Furthermore, Thble r5.r gives a zoo5 dividend (D,) of $o.+8 and an end-of-year 109 3. 110 Cases in Healthcare Finance (December 3r, zoo5, or fanuary r, zoo6) stock price (p ) of $B.oo. a. What is the expected rate of return on potomac's stock if it was purchased on January 4 zoo6? b. What is the expected dividend yield and expected capital gains yield? c. What is the relationship behveen dividend yield and capital gains yield over time under constant growth assumptions? d. What conditions must hold to use the constant growth model? Do many "real-world" stocks satisfu the constant growth assumptions? e. Plot the expected rate of return found in Part a on the SML graph from question 3. Based on the data developed so far, would you buy Potomac's stock? Now consider the fact that Value Line actually predicted that Potomac's dividends would grow at a ro percent rate for the next five years, and then the growth rate would fall to a steady state (constant)4 percent inio the foreseeable future. a. Under these conditions, what is the value of Potomac's siock at the beginning of zoo6? (Hint: Lay out the expected dividends on a timeline up to and including the first year of constant [4 percent] growth. Use the dividend expected in Year 6 and the constant growth model to calculate the value of the stock at the end of Year 5. Discount this Year 5 value, along with the dividends expected in Years r-5 back to Year o. Sum these present values to obtain the value of the stock.) b. Assume that the value you calculated was the actual stock price on January r, zoo6. What is the expected stock price at the end of zoo6 assuming that the stock is in equilibrium? c. What are the expected dividend yield, capital gains yield, and total return for zoo6? d. Repeat the Part c analysis for zooT. What happens to the expected dividend and capitalgains yields Potomac Healthcare (B) from zoo6 to zooT? What are the expected dividend and capital gains yields for zrrr? Potomac's stock price was actually $B.oo at the beginning of zoo6, Using the growth rates given in Table r5.r (and also used in question 5), what is the stock's expected rate of return? (Hint: This is not an easy question. A model similar to the one used to answer question 5 must be applied, but a trial-and-error technique must be used to find the discount rate that discounts the expected dividend land Year 5 stock value] stream back to the current price, $B.oo. The process is complicated by the fact that each discount rate selected in the trial-and-error process must be used to find ihe Year 5 stock value before it is used to discount the expected cash flow stream back to Year o.) What is the efficient markets hypothesis, and what are its implications for stock investors? til f U- -

Paper#4148 | Written in 18-Jul-2015

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