Universal Health Care (UHC) is a company whose stock price has declined by 40% in the last year. In the current year, UHC earned $300 million in pre-tax operating income on revenues of $10 billion. The new CEO of the firm has proposed cost-cutting measures she anticipates will save the firm $100 million in expenses, without any effect on revenues. Assume the firm is growing at a stable rate of 5% a year and its cost of capital is 10%; neither number is expected to change as a consequence of the cost cutting. The firm’s tax rate is 40%. (You can assume that the firm reinvests $100 million each year and that this reinvestment will not change as the firm cuts costs.)
- What effect will the cost cutting have on value?
- What effect will the cost cutting have on value, if the expected growth rate will drop to 4.5% as a consequence? (Some of the costs cut were designed to generate future growth)