Problem 1:
New Hope Managed Care Inc., is a for-profit managed care company that serves the southwest United States. Last year, it reported $1,200,000 in income from operations, $250,000 in interest income from bonds it bought in the previous year, and $60,000 in dividend income from shares in a large drug company. New Hope also has $200,000 in surplus funds that it is considering investing in bonds that pay interest of $10,000 per year or stock that pays dividends of $9,000 per year.
a. What is New Hope's tax liability?
b. What is New Hope's marginal tax rate? Average tax rate?
c. Should New Hope invest its surplus funds in bonds or stock?
Problem 2:
Johnson Family Care Inc. is a large ambulatory care center that provides comprehensive 24-hourprimary and specialty care to a large suburban population in Pennsylvania. The center recently purchased new clinical laboratory equipment for $1.1 million and spent $22,000 to renovate a center room to accommodate the new equipment. The useful life of the equipment is estimated to be ten years, after which it can be sold for $75,000. Johnson uses a straight-line method to calculate book depreciation and pays tax at a rate of 40 percent. The equipment falls into the MACRS seven-year class.
a. What annual depreciation expense will be reported on the income statement for the center?
b. What annual depreciation expense will be reported for tax purposes?
c. Suppose Johnson sells the laboratory equipment at the end of Year 4 for $400,000. What impact would this have on the taxes paid by the center?
Problem 3:
Consider the following probability distribution of returns estimated for a proposed project that involves a new ultrasound machine:
State of the Probability Rate of Economy of Occurrence Return
Very Poor 0.1 -10%
Poor 0.2 0%
Average 0.4 10%
Good 0.2 20%
Very Good 0.1 30%
a. What is the expected rate of return on the project?
b. What is the project's standard deviation of returns?
c. What is the project's coefficient of variation (CV) of returns?
d. What type of risk does the standard deviation and CV measure?
e. In what situation is this risk relevant?
Southeastern Specialty, Inc. (SSI)—Financial Risk
State of the Economy Probability 1-Year T-Bill Project A Project B S&P Fund Equity in SSI
Poor 0.10 7.0% -8.0% 18.0% -15.0% 0.0%
Below Average 0.20 7.0% 2.0% 23.0 % 0.0 % 5.0%
Average 0.40 7.0% 14.0% 7.0% 15.0% 10.0%
Above Average 0.20 7.0% 25.0% -3.0% 30.0% 15.0%
Excellent 0.10 7.0% 33.0% 2.0% 45.0% 20.0%
Suppose SSI forms a two-asset portfolio by investing in both Project A and B.
a. To begin, assume that the required investment is the same for both projects-say, $5 million each.
1) What will be the portfolio’s expected rate of return, standard deviation, and coefficient of variation?
2) How do these values compare with the corresponding values for the individual projects?
3) What characteristic of the two return distributions make risk reduction possible?
b. What do you think will happen to the portfolio’s expected rate of return and standard deviation if the portfolio contained 75 percent of Project A? If it contained 75 percent of Project B?