Problem:
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 how is project risk is incorporated into a capital budgeting analysis.