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Hospital Corporation Of America

Group 8 Division C
1. Parth Dave 178 2. Udit Dave 179 3. Ashish Bharadwaj 181 4. Krutik Dedhia 218 5. Atharva Oswal 219 6. Raj Shah 323 7. Dhruv Kalia - 324

Hospital Corporation Of America


HCA is a proprietary hospital management company. It owns and manages chains of hospitals on a for-profit basis.

The company has been following acquisitive strategy.


Currently facing a complex financial situation with their ratio of debt to total capital approaching 70%, as opposed to a target ratio of 60%.

Discussion about the case:


Goal of HCA was to maintain a 60% target ratio of debt to total capital for the leverage expectation of an A bond rating. HCA has a ratio of debt to total capital at 68.8%, which will reduce the firms A bond rate. By reducing the ratio of debt to total capital to 60%, the company is able to maintain A-rated hospital management company. New debt value $1152 million as opposed to the current $1692 million.

What Is The Importance Of Capital Structure??


Important to survive the business in long run. Liability side is the mixture of finance of company collected from internal and external sources. Used for development of company. Liability side of balance sheet is made under perfect capital structure planning.

The right capital structure planning also increases the power of company to face the losses and changes in financial markets.

Importance of capital structure and its planning


1. To reduce the overall risk of company: a. Many adjustments for reducing our overall risk. b. Company can enjoy the trading on equity. c. Easily pay the interest because our ROI is very high. To do adjustment according to Business Environment: a. Company also adjusts different sources expected amount according to business environment. b. proper planning of capital structure of future sources will be helpful for us to enlarge our area for getting money. c. it is called manoeuvrability. d. to create mobility of sources of fund by including maximum alternatives in planned capital structure.

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3. Idea generation of new source of fund: a. Good planning of capital structure will make versatile to finance manager for getting money from new sources. b. venture capital or private equity sources precisely understand. c. Finance managers of company are generating new and new idea for getting money from public at low risk. d. Promoters or managers do 10 minutes meeting with investors and motivate them by showing the special event which they have made in PPT.

CAPITAL STRUCTURE (GEARING)


INTRODUCTION: cost of capital of a firm is fundamental in the decision as to whether a proposed project is acceptable. If the return from a project (r) exceeds the cost of capital (ko) then the project should be accepted. If the cash flows from the project were to be discounted at ko then the project would have a positive net present value (N.P.V.). This would be profitable for the firm and will mean an increase in the present net worth.

Illustration 1.1
A firm has $200,000 of cash available for investment, ko = 10%. If the company were to invest the $200,000 in a project with a return greater than ko, then the present value of the firm would increase. Consider a project that will require all the $200,000 now and will return $30,000 per annum indefinitely. Using i = ko = .10 the present value of the income stream =$300,000 (the IRR equals 15%).

Initial assumptions of all models (1) (2) (3) (4) (5) No taxation Immediate change in gearing All earnings distributed All shareholders expect same future earnings No growth in earnings.

THE NET INCOME APPROACH


According to this approach the average cost of capital (ko) declines as gearing increases. The cost of shareholders funds (ks) and the cost of debt (kd) are independent. Since kd is usually less than ks as debt is less risky than equity from the investors point of view, an increase in gearing should lead to a decrease in ko. The strict net income approach assumes that ks and kd remain constant.

Illustration 2.2
Two companies have the same EBIT but different capital structures Company A: E (EBIT) = $80,000 all equity capital Company B: E (EBIT) = $80,000 DEBT = $500,000 @ 6%, remainder equity. The debt service cost (interest) = $30,000 p.a. The expected earnings of shareholders are Company A = $80,000 Company B = $50,000 ($80,000 30,000) Shareholders earnings have greater relative dispersion for Company B than for Company A (coefficient of variation).

THE NET OPERATING INCOME APPROACH


According to this approach, there is no optimal capital structure. The financing mix does not effect the average cost of capital of the company; and the total value of the firm remains unchanged with changes in the gearing. i.e. ko remains constant. k ks kd ko

All capital structures are optimal. The increase in ks is exactly sufficient to offset the effect of the increased importance of kd so ko is constant.

Illustration 3.1
Firm R.C. has an EBIT of $900,000. There is debt of $4 million in the capital structure. kd = 7.5% and WACC (ko) = 10%. The total value of the firm V =$9,000,000 The value of debentures = Thus equity is worth $4,000,000 $5,000,000

If debt is increased to $5 million, ko remains constant.


Value of the firm is still $9 m.

CONCLUSIONS ON CAPITAL STRUCTURE


Decisions on the optimum level of debt will differ from firm to firm. Involve considerations of the firms future strategies and external factors like the rate of inflation. Over a fairly extensive range of gearing ko is relatively less sensitive to changes in the financing mix. The capital mix is the attitude of company management.

As employees, management will tend to put constraints on the level of gearing as they will perceive a decrease in their job security with an increase in financial risk.

Situation as of 1981
Total Debt : $ 1,69,23,23,000 Shareholders equity : $ 76,76,00,000 Total Capital : $ 2,45,99,23,000 Percentage Debt : 68.80 % Objective : Reduce debt percentage to 60 % to consistently have A rating and reduce interests payments do that dividends are not reduced Options : 90 Day commercial paper at 13.5 % 25 years debenture at 16.5 % Common stock trading at $32 per share

Suggested Solution :
1. We cannot use commercial paper as they are a kind of short-term debt and high interest payments will have to be done. That will reduce profits and dividend payouts will be impacted, which the company would not like to. Thus, lets consider the next alternative. Debentures are a part of debt capital. Borrowing capital at 16.5 % for 25 years will have a drastic impact on bottom line. Neither the above nor this alternative is preferred. Thus let us consider the next step. We issue FPO of 10 million shares at $32 per share. This will raise capital of $ 32,00,00,000. Total Capital will increase to $ 2,77,99,23,000 and debt percentage shall decrease to 60.60 %. This will serve the purpose of consistently having a A grade rating and also help raise funds at low interest rates and also company will not have to reduce dividend.

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Thank you

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