A relatively small medical group practice is trying to estimate its corporate co

Question

A relatively small medical group practice is trying to estimate its corporate cost of capital. The practice is 100% equity fianced. The rate of return on 20-year Treasury bonds is currently 6%, and the expected rate of return on the market is 12%. A large practice management firm has a beta coefficient of .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. A what is the best estimate of the firms corporate cost of capital? B how would your estimate of the corporate cost of capital change if the success of the medical group practice was highly dependent on the reputation of a single physician in the group? A relatively small medical group practice is trying to estimate its corporate cost of capital. The practice is 100% equity fianced. The rate of return on 20-year Treasury bonds is currently 6%, and the expected rate of return on the market is 12%. A large practice management firm has a beta coefficient of .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. A what is the best estimate of the firms corporate cost of capital? B how would your estimate of the corporate cost of capital change if the success of the medical group practice was highly dependent on the reputation of a single physician in the group?

Explanation / Answer

A, cost of equity = 6% + 0.9*(12 - 6)% + 4% + 2% = 17.40%

B. since the risk would be concentrated to a particular physician, the overall cost would increase

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