Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Question
Transcribed Image Text:13.9
Problem:
A relatively small medical group practice is trying to estimate its CCC. The practice 100 percent equity financed. The rate of return on 20-year Treasury
bonds is currently 4 percent, and the expected rate of return on the market is 8 percent. A large practice management firm has a beta coefficient of 0.9.
Market research indicates that the cost of equity for very small firms is approximately 4 percentage points higher than the cost of equity for large firms.
Moreover, the investors in the small group practice face liquidity risk and thus determine that a liquidity premium of 2 percentage points is appropriate.
Equity Financed
Rate of Return TB
Rate of Return Market
Big Firm Beta
Small Firm Cost of Equity
Liquidity Premium
100%
4%
8%
0.9
4.0%
2%
a. What is the best estimate of the firm's CCC?
Cost of Equity/Capital
Est Cost of Equity/Capital
b. How would your estimate of the CCC change if the success of the medical group practice was highly dependent on the reputation of a single physician in the
group?
The firm faces additional risk factor known as key person risk because the success of the form is dependent on a single physicians reputation
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