Project 1 $120,000 initial investment, cash flows of $30,000 per year for four y
ID: 2767854 • Letter: P
Question
Project 1
$120,000 initial investment, cash flows of $30,000 per year for four years
Project 2
$500,000 initial investment, cash flows of $125,000 in the first two years, $150,000 in the years 3 and 4, and $175,000 in years 5 and 6
Project 3
$200,000 initial investment, cash flows of $60,000, $80,000 and $95,000
Project 4
$100,000 initial investment if done in-house, cash flows of $27,000 per year for five years $75,000 if outsourced but cash flows of $19,000 per year for five years
Your cost of capital is 7.0% if your capital spending is less than $700,000. It goes up to 8.0% if you exceed that $700,000 threshold.
Project 1 is considered below average risk, Project 2 is above average risk, Project 3 is average risk, Project 4 if done in house is above average risk but average risk if outsourced. Your company uses the Risk-Adjusted Discount Rate method to account for differences in project risk; the risk premium is 3%.
Your task is to make a recommendation to the hospital's board as to which of these projects the hospital should undertake. Justify your recommendations based on the NPV or IRR for the projects using the appropriate cost of capital. Although your recommendations should be based on the risk adjusted calculations, please include in your report what your recommendations would have been without risk adjustments so the board can see how risk entered into your analysis. Should you decide that you can't do all the financially attractive projects, you can use the profitability index (page 589) to inform your recommendation.
Explanation / Answer
Company should take project 2
Project 1 2 3 4-inhouse 4-outsourced cost of capital risk below average above average average risk above average average risk outflow (120,000.00) (500,000.00) (200,000.00) (100,000.00) (75,000.00) 7% year1 30,000.00 125,000.00 60,000.00 27,000.00 19,000.00 7% year2 30,000.00 125,000.00 80,000.00 27,000.00 19,000.00 7% year3 30,000.00 150,000.00 95,000.00 27,000.00 19,000.00 7% year4 30,000.00 150,000.00 27,000.00 19,000.00 7% year5 175,000.00 27,000.00 19,000.00 7% year6 175,000.00 7% risk adjusted year 1 2 3 4-inhouse above average 4-inhouse average cost of capital cost of capital for above average risk outflow 0 (120,000.00) (500,000.00) (200,000.00) (100,000.00) (75,000.00) 7% 10% year1 1 28,037.38 113,636.36 56,074.77 24,545.45 17,757.01 7% 10% year2 2 26,203.16 103,305.79 69,875.10 22,314.05 16,595.34 7% 10% year3 3 24,488.94 112,697.22 77,548.30 20,285.50 15,509.66 7% 10% year4 4 22,886.86 102,452.02 - 18,441.36 14,495.01 7% 10% year5 5 - 108,661.23 - 16,764.88 13,546.74 7% 10% year6 6 - 98,782.94 - - - 7% 10% NPV (18,383.66) 139,535.56 3,498.16 2,351.24 2,903.75 IRR 0.00% 18.41% 7.89% 10.92% 8.43% with out risk adjusted year 1 2 3 4-inhouse above average 4-inhouse average cost of capital outflow 0 (120,000.00) (500,000.00) (200,000.00) (100,000.00) (75,000.00) year1 1 28,037.38 116,822.43 56,074.77 25,233.64 17,757.01 7% year2 2 26,203.16 109,179.84 69,875.10 22,314.05 16,595.34 7% year3 3 24,488.94 122,444.68 77,548.30 20,285.50 15,509.66 7% year4 4 22,886.86 114,434.28 - 18,441.36 14,495.01 7% year5 5 - 124,772.58 - 16,764.88 13,546.74 7% year6 6 - 116,609.89 - - - 7% NPV (18,383.66) 204,263.70 3,498.16 3,039.43 2,903.75 IRR 0.00% 18.41% 7.89% 10.92% 8.43%Related Questions
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