Tae-Hwan Ahn manages a Level III Trauma Center for Medical Corporation of America (MCA), a for-profit corporation that trades on the New York Stock Exchange. Ahn wants to upgrade his facility to a Level II Trauma Center but has been unable to convince top management of the value of this proposition. MCA instead has chosen to invest in other parts of the business. A competing hospital system recently built a Level II Trauma Center, and Ahns facility now faces declining patient traffic and revenues. Headquarters has decided that MCA must either cease operations in this location or upgrade to a Level II Trauma Center to remain competitive. Ahn has gathered data about emergency medicine traffic in the area to assist top management in this decision. MCA uses a 10-year planning horizon for major investments and assumes operating cash flows arrive at year-end. Investment/disinvestment cash flows are recognized as they occur. Inflation is expected to be 2% over MCAs 10-year planning horizon. MCAs nominal after-tax required return (or weighted average cost of capital) is i(WACC) = 10% for renovations such as the Trauma Center. The real required return is not expected to change even if inflation turns out to be higher or lower than expected. MCAs corporate income tax rate is 21% under the 2017 Tax Cut and Jobs Act. MCAs other operations should remain profitable over the 10-year planning horizon. The existing Level III Trauma Center (the Base Case) MCA renovated the Trauma Center five years ago with a $20 million investment in equipment. MCA is depreciating that investment for tax purposes using MACRS (Modified Accelerated Cost Recovery System) 5-year class life toward a salvage value of $0. Under the assumption that investment is made mid-year, assets with a 5-year depreciable life are depreciated over 6 years using annual depreciation percentages of 20%, 32%, 19.2%, 11.52%, 11.52%, and 5.76%. One year of depreciable life remains on MCAs investment from 5 years ago, so the book value of the existing equipment is 5.76% of $20 million or $1,152,000. Ahn estimates the current market value of the existing equipment is $12 million, but that the equipment is likely to have a market value of zero in 10 years. The census at the facility has been stable at about 15,000 patients per year since the competitor built its facility, but this is far from an acceptable utilization rate. Ahn forecasts revenues of $1,000 per patient in the coming year. Most patient visits are for less than this amount, but a few costly visits bump up the average cost. Expected first-year revenues of (15000 patients)($1000/patient) = $15 million are expected to grow with inflation over the 10-year planning horizon. For example, expected revenues in year 2 are (15000 patients)($1000/patient)(1.02) = $15.3 million. The average collection period of the existing facility is one-third of a year (about 120 days), so the receivables balance in the coming year of operations should be around ($15 million)/3 = $5 million. Default rates on collections are negligible at this location. The Level III Trauma Center is available 24-7 as a service to the community. This will require a fixed operating expense of $4 million in the coming year to assure readiness. Ahn assumes this operating expense will grow at the inflation rate. Variable operating expenses for physicians, lab techs, supplies, etc. are expected to be 70% of the average per-patient cost throughout the 10-year planning horizon. 1. Construct a spreadsheet valuation of this investment by discounting nominal cash flows to debt and equity at the 10% nominal required return of debt and equity. a. First, construct a base case assuming continued operation of the Level III Trauma Center. b. Next, identify the incremental cash flows of investing in the alternative Level II Trauma Center. What cash flows will change as a result of a decision to renovate the facility?