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Universal Health Care (UHC) is a company whose stock price has declined by 40% in the past year. In the current year, UHC earned $300 million in pretax operating income on revenues of $10 billion. The new CEO of the firm has proposed costcutting measures she anticipates will save the firm $100 millionin expenses, without any effect on revenues. Assume the firm is growing at astable rate of 5% a year and that its cost of capital is 10%; neither number is expected to change as a consequence of the cost cutting. The firm's tax rate is40%. (You can assume that the firm reinvests $100 million each year and that this reinvestment will not change as the firm cuts costs.)
a. What effect will the cost cutting have on value?
b. What effect will the cost cutting have on value if the expected growth ratewill drop to 4.5% as a consequence? (Some of the costs cut were designed to generate future growth.)
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