UNDERSTANDING HEALTHCARE FINANCIAL MANAGEMENT Chapter 4 -- Financial Risk and Re
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UNDERSTANDING HEALTHCARE FINANCIAL MANAGEMENT Chapter 4 -- Financial Risk and Required Return PROBLEM 5 A few years ago, the Value Line Investment Survey reported the following market betas for the stocks of selected healthcare providers: Company Beta Quorum Health Group 0.90 Beverly Enterprises 1.20 HEALTHSOUTH Corporation 1.45 United Healthcare 1.70 At the time these betas were developed, reasonable estimates for the risk-free rate, RF, and the required rate of return on the market, R(Rm), were 6.5 percent and 13.5 percent, respectively. a. What are the required rates of return on the four stocks? b. Why do their required rates of return differ? c. Suppose that a person is planning to invest in only one stock rather than hold a well-diversified stock portfolio. Are the required rates of return calculated above applicable to the investment? Explain your answer. ANSWER UNDERSTANDING HEALTHCARE FINANCIAL MANAGEMENT Chapter 4 -- Financial Risk and Required Return PROBLEM 5 A few years ago, the Value Line Investment Survey reported the following market betas for the stocks of selected healthcare providers: Company Beta Quorum Health Group 0.90 Beverly Enterprises 1.20 HEALTHSOUTH Corporation 1.45 United Healthcare 1.70 At the time these betas were developed, reasonable estimates for the risk-free rate, RF, and the required rate of return on the market, R(Rm), were 6.5 percent and 13.5 percent, respectively. a. What are the required rates of return on the four stocks? b. Why do their required rates of return differ? c. Suppose that a person is planning to invest in only one stock rather than hold a well-diversified stock portfolio. Are the required rates of return calculated above applicable to the investment? Explain your answer. ANSWERExplanation / Answer
a. Working formula
Required retrun = Risk free rate + beta * (Market retrun - Risk free rate)
Required return
Quorum Health Group = 6.5% + 0.90 * (13.5% - 6.5%)
= 12.80%
Beverly Enterprises = 6.5% + 1.20 * (13.5% - 6.5%)
= 14.90%
HEALTHSOUTH Corporation = 6.5% + 1.45 * (13.5% - 6.5%)
= 16.65%
United Healthcare = 6.5% + 1.70 * (13.5% - 6.5%)
= 18.40%
b. The rates of return vary from stock to stock primarily due the different beta factor which is the relative movement in the price of the stock w.r.t. the market.
c. Yes, the above return calculation would be instrumental to the investment decision as it would enable the investor to gauze the return as against the risk (beta factor) associated.
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