Mini Case Chapter 11

James Polk Hospital has currently unused space in its lobby. In three years, the space will be required for a planned expansion, but the hospital is considering uses of the space until then. The hospital has decided that it wants to purchase at least one and maybe two fast food franchises, to take advantage of the high volume of patients and visitors that walk through the lobby all day long. The hospital plans to purchase the franchise(s), operate them for three years, and then close them down. The hospital has narrowed its selection down to two choices:

Franchise L: Lisa's Soups, Salads, and Stuff

Franchise S: Sam's Wonderful Fried Chicken

The net cash flows shown below include the costs of closing down the franchises in Year 3 and the forecast of how each franchise will do over the three-year period. Franchise L serves breakfast and lunch, while Franchise S serves only dinner, so it is possible for the hospital to invest in both franchises. The hospital believes these franchises are perfect complements to one another: The hospital could attract both the breakfast/lunch and dinner crowds and both the health-conscious and not-so-health-conscious crowds without the franchises directly competing against one another. The corporate cost of capital is 10 percent.

	Net cash flows
Year	Franchise S	Franchise L
0	-$100	-$100
1	$70	$10
2	$50	$60
3	$20	$80

a. Calculate each franchise's payback period, net present value (NPV), internal rate of return (IRR), and modified internal rate of return (MIRR).

b. Graph the NPV of each franchise at different values of the corporate cost of capital from 0 to 24 percent in 2 percent increments.

- How sensitive are the franchise NPVs to the corporate cost of capital?

- Why do the franchise NPVs differ in their sensitivity to the corporate cost of capital?

- At what cost of capital does each franchise intersect the X-axis? What are these values?

c. Which project or projects should be accepted if they are independent? Which project should be accepted if they are mutually exclusive?

d. Suppose the hospital could sell off the equipment for each franchise at the end of any year. Use NPV to determine the optimal economic life of each franchise when the salvage values are as follows:

	Salvage value
Year	Franchise S	Franchise L
0	$100	$100
1	$60	$70
2	$20	$30
3	$0	$0