Case 18

Introduction
The Southeastern Homecare was founded in 1992 in Miami, Florida by Maria Gonzalez, MD;
Ramon Garcia, RN; and Ron Sparks, LPT as a taxable partnership. Its purpose was to provide an
alternative to hospitals and outpatient care facilities. After six years of rapid growth, the external
capital exhausted the owners personal funds, leaving them no choice but to borrow to finance
the rapid growth of the company.
1) What corporate cost of capital (CCC) do you estimate for Southeastern Homecare?
WACC= 5% + 1.3 (7% - 5%)
WACC= 7.6%

2) The companys financial plan calls for the issue of 30-year bonds to meet long-term debt
needs. How valid is an estimate of the cost of debt based on 15-year bonds? If the
estimate is not valid, how might it be adjusted to remove any bias?

The 15 years estimate of long-term debt is biased because there is still tax deductibility of
the cost of debt as the equity is not considered as a tax expense. In this case, the corporate
tax system favors debt over equity. Therefore, the firm needs to assess the long-run
response to leverage and reduce it to be less than the cost of equity.

3) The Board Chair is concerned about factors that affect the corporate cost of capital for
any business: the level of interest rates, tax rates, capital structure policy, and capital
investment policy. Does the tax rate, cost of debt, or cost of equity have the most
influence on the CCC of Southeastern Homecare? Why?

The cost of debt remains unchanged after some time. The cost of equity increases as the
gearing increases. It is therefore, evident that it is equity that has most influence on the
corporate cost of capital than the cost of debt.