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PROBLEM 1: Week 5 and Week 6 Capital Budgeting Assume that you are the CFO at Methodist Hospital in San Antonio. The CEO has asked
PROBLEM 1: Week 5 and Week 6 Capital Budgeting | ||||||||||||||
Assume that you are the CFO at Methodist Hospital in San Antonio. The CEO has asked you to | ||||||||||||||
analyze two proposed capital investments: Project X and Project Y. Each project requires a net | ||||||||||||||
investment outlay of $10,000, and the cost of capital for each project is 12 percent. The project's expected | ||||||||||||||
net cash flows are as follows: | ||||||||||||||
Year | Project X | Project Y | ||||||||||||
0 | -$11,000 | -$11,000 | ||||||||||||
1 | $7,000 | $3,000 | ||||||||||||
2 | $3,000 | $3,000 | ||||||||||||
3 | $3,000 | $4,000 | ||||||||||||
4 | $1,000 | $4,000 | ||||||||||||
a. Calculate each project's payback period, net present value (NPV), and internal rate of return (IRR). | ||||||||||||||
b. Which project (or projects) is financially acceptable? Explain your answer. | ||||||||||||||
a. Complete the table below, solving for the project's cash flows, paybacks, NPVs (at 12 percent), and IRRs. | ||||||||||||||
Project X | Project X | Project Y | Project Y | |||||||||||
Annual | Cumulative | Annual | Cumulative | |||||||||||
Year | Cash Flow | Cash Flow | Cash Flow | Cash Flow | ||||||||||
0 | ||||||||||||||
1 | ||||||||||||||
2 | ||||||||||||||
3 | ||||||||||||||
4 | ||||||||||||||
Payback | ||||||||||||||
NPV | ||||||||||||||
IRR | ||||||||||||||
b. Which project (or projects) is financially acceptable? Explain your answer. | ||||||||||||||
PROBLEM 2: Week 5 and Week 6 Capital Budgeting | ||||||||||||||
HCA is evaluating the bulk purchase of new Hill-Rom hospital beds for its Central & West Texas region. The purchase will cost $36,000,000 and the | ||||||||||||||
beds have an expected life of five years. The expected pretax salvage value after five years of use is $4,000,000. In total, the beds are expected to | ||||||||||||||
generate $9,000,000 in revenue in the first year of operations. | ||||||||||||||
Maintenance costs are expected to be $200,000 during the first year of operation, while the increase in utilities will cost another $100,000 across | ||||||||||||||
the system in Year 1. The cost for additional expendable supplies is expected to average $250,000 during the first year. All costs and revenues, | ||||||||||||||
except depreciation, are expected to increase at a 2.8% inflation rate after the first year. The hospital's aggregae tax rate is 21.15%, and its | ||||||||||||||
corporate cost of capital is 8.4%. | ||||||||||||||
The equipment falls into the MACRS five-year class for tax depreciation and hence is subject to the following depreciation allowances: | ||||||||||||||
Year | Allowance | |||||||||||||
1 | 20% | |||||||||||||
2 | 32% | |||||||||||||
3 | 19% | |||||||||||||
4 | 12% | |||||||||||||
5 | 11% | |||||||||||||
6 | 6% | |||||||||||||
a. Estimate the project's net cash flows over its five-year estimated life. | ||||||||||||||
b. What are the project's NPV and IRR? (Assume that the project has average risk.) | ||||||||||||||
c. Based on the results of the analysis, should this project be approved? | ||||||||||||||
a. Complete the table below, solving for the project's net cash flows over its five-year estimated life. | ||||||||||||||
0 | 1 | 2 | 3 | 4 | 5 | |||||||||
Equipment cost | -$36,000,000 | |||||||||||||
Net revenues | ||||||||||||||
Less: | Maintenance costs | |||||||||||||
Utilities costs | ||||||||||||||
Supplies | ||||||||||||||
Depreciation | ||||||||||||||
Operating income | ||||||||||||||
Taxes | ||||||||||||||
Net operating income | ||||||||||||||
Depreciation | ||||||||||||||
Plus: After-tax equipment salvage value* | ||||||||||||||
Net cash flow | -$36,000,000 | |||||||||||||
b. What are the project's NPV and IRR? (Assume that the project has average risk.) | ||||||||||||||
c. Based on the results of the analysis, should this project be approved? | ||||||||||||||
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