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As you advance in your health care career, you may or may not serve in a financial capacity. If you do, it will be very important for you to understand the cost of capital and recognize the fact that having a solid understanding of this concept allows the financial manager to make wise business decisions concerning capital investment projects that the entity may undertake.
Assume that you are the financial manager for Healthy Body Hospital and you have been asked to explain about the cost of capital to a group of non-financial managers who are also employed at this hospital. In advance of your presentation, you have been given the following three questions. Write a paragraph of approximately 100 words in response to each of these questions that will help guide your explanation to the group that you will be addressing.
Because you will be speaking to a group of non-financial managers, in your own words, explain what exactly is meant by the term “cost of capital”. Prior to undertaking any capital budget project, is it important for a financial manager to understand the cost of capital? Why or why not? (7 points)
What are we referring to when we discuss the “optimal capital structure” of a business? Why is the optimal capital structure also referred to as the “target capital structure”?
For a health care entity, in particular, what are some factors that you must consider when determining the entity’s target capital structure?
In addition, you decide that you would like to walk the group through the following problem and demonstrate how to calculate the corporate cost of capital. Show the calculation that is needed to determine the correct answer.
Healthy Body Hospital has a target capital structure of 35 percent debt and 65 percent equity. Its cost of equity estimate is 13 percent and its cost of tax-exempt debt estimate is 7.5 percent. What is the hospital’s corporate cost of capital?