The staff of Jefferson Memorial Hospital has estimated the following net cash fl

Question

The staff of Jefferson Memorial Hospital has estimated the following net cash flows for a satellite food service operation:

y0 -100,000

y1 30,000

y2 30,000

y3 30,000

y4 30,000

y5 30,000

5 (salvage value) 20,000

the year 0 cash flow is the investment cost of the new food service, while the final amount is the terminal cash flow. (the clinic is expected to move to a new building in five years) All other flows represent net operating cash flows. JEfferson's corporate cost of capital is 10 percent.

a. What is the projects IRR? its MIRR?

b. Assuming hte project has average risk, what is its NPV?

c. Now assume that the operating cash flows in year 1 through 5 could be as low as 20,000 or as high as 40,000. Furthermore, the salvage calue cash flow at the end of year 5 could be as low as 0 or as high as 30,000. What are the worst-case and best-case IRRs? THe worst-case and best case NPVs?

Explanation / Answer

a. IRR is the rate which makes the NPV as 0. We calculate the IRR on excel, using trail and error approach, till we find the rate which makes the NPV as 0.

The discount rate is 1.1905. So, IRR = 1.1905 -1 = 0.1905 = 19.05%

MIRR calculation:

Cost of capital = 10%.

Present value of cost = 100,000

Terminal value of cash inflows = 30,000(1.10)^4+30,000(1.10)^3+30,000(1.10)^2+30,000(1.10)^1+30,000+20,000 = 203,153

MIRR is obtained using the following formula:

100,000 = 203,153/(1+mirr)^5

(1+mirr)^5 = 2.03153

1+mirr = 1.1523

MIRR = 0.1523 or 15.23%

b. NPV:

Discount factor will be (1+cost of capital) = 1.10

Formula for PV = amount/(discount factor)^time

npv = $26,142

c. worst case IRR (cash flow of 20,000 and salvage value of 0)

So, IRR = discount factor -1 = 1-1 = 0.

best case IRR (cash flow of 40,000 and salvage value of 30,000)

IRR = Discount factor -1 = 1.3264 - 1 = 32.64%

worst case NPV (cash flow of 20,000 and salvage value of 0), at discount factor of 1.10 (1+10%)

best case NPV (cash flow of 40,000 and salvage value of 30,000), at discount factor of 1.10 (1+10%)

Year Cash flow Discount factor PV 0 -100,000 1.1905 -100,000 1 30,000 25,200 2 30,000 21,169 3 30,000 17,782 4 30,000 14,937 5 30,000 12,547 5 20,000 8,365 Total PV 0

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