9.14 County Hospital is planning to purchase a new piece of medical equipment with a list price of $300,000,000. The medical equipment supplier has been experiencing low sales volume due to the recession and is currently offering special pricing to boost sales. The medical equipment supplier provides county Hospital with the following two alternative offers:

Offer 1: county can purchase the medical equipment at a 10 percent discount (sale price) if it pays full amount at the time of purchase.

Offer 2: county can purchase the medical equipment at a 5 percent discount (sale price) with two-year, no-cost financing. If County chooses Offer 2, half of the final punching price will be due at the end of year 1 and half of the final purchase price will be due at the end of Year 2.

Assuming County has enough cash available to take advantage of either offer and will not need to borrow any money to complete the purchase.

A. Which offer should County Hospital take if its risk-adjusted opportunity cost of capital is 10 percent?

B. Which offer should County Hospital take if its risk-adjusted opportunity cost of capital is 1 percent?

C. Explain why your answers were either the same or different for parts A and B.

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Hint for 9.14: To solve this problem, first determine the net price of the equipment under each offer;

Offer 1 provides a 10% discount off of the list price, so the net price is $3,000,000 90% = $2,700,000.

Offer 2 provides a 5% discount off of the list price, so the net price is $3,000,000 95% = $2,850,000.

Next, it is necessary to determine the timing of the cash flows under each offer.

If Offer 1 is accepted, the full net price is due immediately, resulting in a $2,700,000 cash flow at Time 0.

If Offer 2 is accepted, half of the net price is due at the end of Year 1 and half of the net price is due at the end of Year 2, resulting in an ordinary annuity cash flow of $1,425,000 in years 1 and 2 ($2,850,000 2). Because the cash flows occur at different points on the time line, discounting must be used to value them all at Time 0 so that the offers can be compared.