Question
NEED VALUES FILLED IN WHERE IT SAYS -$1, $0, and 1. PLEASE and THANK YOU Shrieves Hospital Ltd. is considering adding a new line to
| NEED VALUES FILLED IN WHERE IT SAYS -$1, $0, and 1. PLEASE and THANK YOU Shrieves Hospital Ltd. is considering adding a new line to its diagnostic product mix, and the capital | |||||||||
| budgeting analysis is being conducted by Sidney Johnson, a recently graduated MHA. A new bone density | |||||||||
| scanner would be set up in unused space in Shrieves's main clinic. The machinerys invoice price would be | |||||||||
| approximately $200,000; another $10,000 in shipping charges would be required; and it would cost an | |||||||||
| additional $30,000 to install the equipment. The machinery has an economic life of four years, and Shrieves | |||||||||
| has obtained a special tax ruling which places the equipment in the MACRS three-year class. The machinery | |||||||||
| is expected to have a salvage value of $25,000 after four years of use. The new line would generate | |||||||||
| incremental sales of 1,250 scans per year for four years at an incremental cost of $100 per scan in the | |||||||||
| first year, excluding depreciation. Each scan would generate revenue of $200 in the first year. The price | |||||||||
| and cost of each scan are expected to increase by 3 percent per year due to inflation. Further, to handle | |||||||||
| the new line, the hospital's net operating working capital would have to increase by an amount equal to 12 | |||||||||
| percent of sales revenues*. The hospital's tax rate is 40 percent, and its corporate cost of capital is 10 | |||||||||
| percent. | |||||||||
| a. Perform a sensitivity analysis on the corporate cost of capital, number of scans, and salvage value. | |||||||||
| Assume that each of these variables can vary from its base case by plus and minus 15 and 30 percent. | |||||||||
| Include a sensitivity diagram. | |||||||||
| b. Perform a scenario analysis using the worst-, most likely, and best-case probabilities in the table below: | |||||||||
| Number of | Price | ||||||||
| Scenario | Probability | scans | per scan | ||||||
| Best | 25% | 1,600 | $240 | ||||||
| Most likely | 50% | 1,250 | $200 | ||||||
| Worst | 25% | 900 | $160 | ||||||
| c. Assume that Shrieves's average project has a coefficient of variation of NPV in the range of 0.20.4. | |||||||||
| The hospital typically adds or subtracts 3 percentage points to its corporate cost of capital to adjust for | |||||||||
| risk. Should the new line be accepted? | |||||||||
| * | |||||||||
| In the section entitled "Changes in Net Working Capital" in Chapter 11, Gapenski states that expansion | |||||||||
| projects require additional inventories and accounts receivable which must be financed, just as an increase | |||||||||
| in fixed assets must be financed. In this situation, the hospital's net working capital would have to increase | |||||||||
| by an amount equal to 12 percent of sales. Sales in Year 1 are estimated at $250,000, so Shrieves must | |||||||||
| have (.12 * $250,000 =) $30,000 in net working capital at Year 0. If sales increase to $257,500 in Year 2, | |||||||||
| Shrieves must have (.12 * $257,500 =) $30,900 at Year 1. Because it already has $30,000 of net working | |||||||||
| capital on hand, its net investment in working capital at Year 1 is just ($30,900 - $30,000 =) $900. If sales | |||||||||
| increase to $265,225 in Year 3, its net investment in working capital in Year 2 is (.12 * 265,225 =) | |||||||||
| $31, 827 - $30,900 = $927. If sales increase to $273,182 in Year 4, its net investment in working capital | |||||||||
| in Year 3 is (.12 * 273,182 =) $32,782 - $31,827 = $955. Shrieves will have no sales after Year 4, so it will | |||||||||
| require no working capital at Year 4. Thus, it would have a positive cash flow of $32,782 at Year 4 as | |||||||||
| working capital is sold but not replaced. DON'T HARD CODE THESE NUMBERS! | |||||||||
| ANSWER | |||||||||
| Equipment cost | -$1 | Number of scans | 0 | ||||||
| Shipping charge | -$1 | Price per scan | $1 | ||||||
| Installation charge | -$1 | Cost per scan | -$1 | ||||||
| Pretax equipment salvage value | $1 | Inventory/sales | -1% | ||||||
| Tax rate | -1% | Annual inflation rate | 1% | ||||||
| Corporate cost of capital | 1% | ||||||||
| MACRS recovery allowances | 1% | 1% | 1% | 1% | |||||
| 0 | 1 | 2 | 3 | 4 | |||||
| Equipment cost | $0 | $0 | $0 | $0 | $0 | ||||
| Sales | $0 | $0 | $0 | $0 | |||||
| Less: | Costs | $0 | $0 | $0 | $0 | ||||
| Depreciation | $0 | $0 | $0 | $0 | |||||
| Operating income before taxes | $0 | $0 | $0 | $0 | |||||
| Taxes | $0 | $0 | $0 | $0 | |||||
| Net operating income after taxes | $0 | $0 | $0 | $0 | |||||
| Less: Investment in working capital | $0 | $0 | $0 | $0 | $0 | ||||
| Plus: Depreciation | $0 | $0 | $0 | $0 | |||||
| Plus: After-tax equipment salvage value* | $0 | ||||||||
| Net cash flow | $0 | $0 | $0 | $0 | $0 | ||||
| * | |||||||||
| Pretax equipment salvage value | $0 | ||||||||
| MACRS equipment salvage value | $0 | ||||||||
| Difference | $0 | ||||||||
| Taxes | $0 | ||||||||
| After-tax equipment salvage value | $0 | ||||||||
| NPV | $0 | ||||||||
| IRR | $0 | ||||||||
| MIRR | $0 | ||||||||
| a. | |||||||||
| Change | |||||||||
| from | Number | Salvage | |||||||
| Base Case | CCC | of scans | value | ||||||
| -30% | 0.0% | 0 | $0 | ||||||
| -15% | 0.0% | 0 | $0 | ||||||
| 0% | 0.0% | 0 | $0 | ||||||
| 15% | 0.0% | 0 | $0 | ||||||
| 30% | 0.0% | 0 | $0 | ||||||
| Change |
| NPV |
| ||||||
| from | Number | Salvage | |||||||
| Base Case | CCC | of scans | value | ||||||
| -30% | $0 | $0 | $0 | ||||||
| -15% | $0 | $0 | $0 | ||||||
| 0% | $0 | $0 | $0 | ||||||
| 15% | $0 | $0 | $0 | ||||||
| 30% | $0 | $0 | $0 | ||||||
| GRAPH | |||||||||
| b. | |||||||||
| Change the number of scans and price per scan in cells I51 and I52 to the values in the table below and | |||||||||
| you will obtain the NPVs in the far right column in the table below. | |||||||||
| Number | Price | ||||||||
| Scenario | Probability | of scans | per scan | NPV | |||||
| Best case | 0% | 0 | $0 | $0 | |||||
| Base case | 0% | 0 | $0 | $0 | |||||
| Worst case | 0% | 0 | $0 | $0 | |||||
| c. | |||||||||
| Here are the expected NPV and standard deviation of the scenario analysis: | |||||||||
| E(NPV) | $0 | ||||||||
| Variance | $0 | ||||||||
| St dev | $0 | ||||||||
| CV | 0.0 | ||||||||
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