A hospital director is considering two alternative investment programs. Both hav

Question

A hospital director is considering two alternative investment programs. Both have costs of $5,000 in year 1 only. Project 1 provides benefits of $2,000 in each of the first 4 years only. Project 2 provides benefits of $2,000 for years 6 to 10 only.

A.) Compute the net benefits using a discount rate of 6 percent.

B.) Knowing that the calculations are dependent on the discount rate, conduct a sensitivity analysis by re-calculating with a discount rate of 12 percent. Based on your calculations, which investment program should the director choose?

Explanation / Answer

A. )

at 6%, Net benefit of Project 1 = $1,820.95

Net benefit of Project 2 = $1,578.47

B.)

at 12%, Net benefit of project 1 = $959.55

and project 2 = -373.39

Thus, in both cases, project 1 has a higher net benefit than project 2. Thus the director should choose Project 1

year Project 1 Present value factor = 1/1.06^year PV of Project 1 Project 2 PV of Project 2 1 -5000 0.9434 -4716.98 -5000 -4716.98 2 2000 0.8900 1779.99 0 0.00 3 2000 0.8396 1679.24 0 0.00 4 2000 0.7921 1584.19 0 0.00 5 2000 0.7473 1494.52 0 0.00 6 0.7050 2000 1409.92 7 0.6651 2000 1330.11 8 0.6274 2000 1254.82 9 0.5919 2000 1183.80 10 0.5584 2000 1116.79 Total PV 1820.95 1578.47

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