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home / study / business / finance / questions and answers / james polk hospital has currently unused space ... Your question has been answered! Rate it below. Let us know if you got a helpful answer. Question: James Polk Hospital has currently unused space in its lobby. In three years, the space will be required for a planned expansion, but the hospital is considering uses of the space until then. The hospital has decided that it wants to purchase at least one and maybe two fast food franchises, to take advantage of the high volume of patients and visitors that walk through the lobby all day long. The hospital plans to purchase the franchise(s), operate them for three years, and then close them down. The hospital has narrowed its selection down to two choices: Franchise L: Lisa's Soups, Salads, and Stuff Franchise S: Sam's Wonderful Fried Chicken The net cash flows shown below include the costs of closing down the franchises in Year 3 and the forecast of how each franchise will do over the three-year period. Franchise L serves breakfast and lunch, while Franchise S serves only dinner, so it is possible for the hospital to invest in both franchises. The hospital believes these franchises are perfect complements to one another: The hospital could attract both the breakfast/lunch and dinner crowds and both the health-conscious and not-so-health-conscious crowds without the franchises directly competing against one another. The corporate cost of capital is 10 percent. Net cash flows Year Franchise S Franchise L 0 -$100 -$100 1 $70 $10 2 $50 $60 3 $20 $80 a. Calculate each franchise's payback period, net present value (NPV), internal rate of return (IRR), and modified internal rate of return (MIRR). b. Graph the NPV of each franchise at different values of the corporate cost of capital from 0 to 24 percent in 2 percent increments. - How sensitive are the franchise NPVs to the corporate cost of capital? - Why do the franchises NPVs differ in their sensitivity to the corporate cost of capital? - At what cost of capital does each franchise intersect the X-axis? What are these values? c. Which project or projects should be accepted if they are independent? Which project should be accepted if they are mutually exclusive? d. Suppose the hospital could sell off the equipment for each franchise at the end of any year. Use NPV to determine the optimal economic life of each franchise when the salvage values are as follows: Salvage value Year S L 0 $100 $100 1 $60 $70 2 $20 $30 3 $0 $0 James Polk Hospital has currently unused space in its lobby. In three years, the space will be required for a planned expansion, but the hospital is considering uses of the space until then. The hospital has decided that it wants to purchase at least one and maybe two fast food franchises, to take advantage of the high volume of patients and visitors that walk through the lobby all day long. The hospital plans to purchase the franchise(s), operate them for three years, and then close them down. The hospital has narrowed its selection down to two choices: Franchise L: Lisa's Soups, Salads, and Stuff Franchise S: Sam's Wonderful Fried Chicken The net cash flows shown below include the costs of closing down the franchises in Year 3 and the forecast of how each franchise will do over the three-year period. Franchise L serves breakfast and lunch, while Franchise S serves only dinner, so it is possible for the hospital to invest in both franchises. The hospital believes these franchises are perfect complements to one another: The hospital could attract both the breakfast/lunch and dinner crowds and both the health-conscious and not-so-health-conscious crowds without the franchises directly competing against one another. The corporate cost of capital is 10 percent. .Question Suppose the hospital could sell off the equipment for each franchise at the end of any year. Use NPV to determine the optimal economic life of each franchise when the salvage values are as follows: Franchise S is Year 0 $100 Year 0 $100 Year 1 $60 Year 2 $20 Year 3 $0 Franchis L Year 0 $100 Year 1 $70 Year 2 $30 Year 3 $0.00
Explanation / Answer
TABLE SHOWING NPVs at different COC:
COC
NPV-S
2
36
4
31
6
27
8
24
10
20
12
17
14
13
16
10
18
7
20
5
22
2
24
-1
COC
NPV-L
2
43
4
36
6
30
8
24
10
19
12
14
14
9
16
4
18
0
20
-4
22
-7
24
-11
Graph of NPV of S cuts the X axis at approximately 23% and for Project L it is at 18%.
NPV of L is more sensitive to changes in COC. The reason for difference in sensitiveness is the difference in the pattern of cash flows.
a) Franchise - S: Cumulative Year Cash flows cash inflows pvif @ 10% PV at 10% pvif @ 20% PV @ 20% pvif @ 25% PV @ 25% fvif @ 10% FV @ 10% 0 -100 1 70 70 0.9091 64 0.8333 58 0.8000 56 1.2100 84.70 2 50 120 0.8264 41 0.6944 35 0.6400 32 1.1000 55.00 3 20 140 0.7513 15 0.5787 12 0.5120 10 1.0000 20.00 120 105 98 159.70 Payback = 1 + 30/50 = 1.6 years NPV = 120 - 100 = $20 IRR = 20 + 5(5/7) = 23.57% MIRR = 3(159.7/100) - 1 = 16.89% Franchise - L: Cumulative Year Cash flows cash inflows pvif @ 10% PV at 10% pvif @ 20% PV @ 20% fvif @ 10% FV @ 10% 0 -100 1 10 10 0.9091 9 0.8333 8 1.2100 12.10 2 60 70 0.8264 50 0.6944 42 1.1000 66.00 3 80 150 0.7513 60 0.5787 46 1.0000 80.00 119 96 158.10 Payback = 2 + 30/80 = 2.38 years NPV = 119 - 100 = $19 IRR = 10 + 10(19/23) = 18.26% MIRR = 3(158.1/100) - 1 = 16.50% c) If the projects are independent both of them can be accepted as they have positive NPVs and their IRR>COC If they are mutually exclusive, Franchise S should be accepted as it has higher NPV. d) Optimal economic life: Franchise - S: Cumulative Salvage PV of Salvage Equivalent Year Cash flows pvif @ 10% PV at 10% PV Value Value NPV pvifa @ 10% Annual NPV 0 -100 100 100 0 0 1 70 0.9091 64 64 70 64 27 0.9091 30 2 50 0.8264 41 105 30 25 30 1.7355 17 3 20 0.7513 15 120 0 0 20 2.4869 8 120 Optimal economic life = 1 year for which the Uniform equivalent NPV is highest. Franchise - L: Cumulative Salvage PV of Salvage Equivalent Year Cash flows pvif @ 10% PV at 10% PV Value Value NPV pvifa @ 10% Annual NPV 0 -100 100 100 0 0 1 10 0.9091 9 9 60 55 -36 0.9091 -40 2 60 0.8264 50 59 20 17 -25 1.7355 -14 3 80 0.7513 60 119 0 0 19 2.4869 8 119 Optimal economic life = 3 years for which alone the Uniform equivalent NPV is positive.Related Questions
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