Question

Please show all work & calculations.

Assume that you are the chief financial officer at Porter Memorial Hospital. The CEO has asked you to analyze two proposed capital investments - Project X and Project Y. Each project requires a net investment outlay of $10,000, and the cost of capital for each project is 12 percent. The project's expected net cash flows are as follows: Year 0 1 Project X ($10,000) $6,500 $3,000 $3,000 $1,000 Project Y ($10,000) $3,000 $3,000 $3,000 $3,000 2 3 4 a. Calculate each project's payback period, net present value (NPV), and internal rate of return (IRR). Year Cumulative Cash Flows Project X Project Y ($10,000) ($10,000) 0 1 2. 3 4 Payback NPV IRR b. Which project (or projects) is financially acceptable? Explain your answer.

Answer 1

A B F G H 1 2 3 a Calculation of Payback Period Year Project X Cumulative Cash Flows Project Y 4 1 5 6 7 $ $ $ $ 2 3 4 6,500 3,000 3,000 1,000 6500||$ 9500 $ 12500||$ 13500||$ Cumulative Cash Flows 3000 6000 9000 12000 3,000 3,000 3,000 3,000 8 9 10 11 12 13 14 15 16 17 18 19 Now, Payback Period refers to the period in which the project will generate the necessary cash to recoup the initial investment So, from the above it is clear that Porter Memorial Hospital recoup his investment in Project X in 3rd Year, as in 3rd Year Cumulative Cash Flows ($12500) exceeds his total investment ($10000) and that of in Project Y in 4th year, as in 4th year Cumulative Cash Flows ($12000) exceeds his total investment ($10000). Payback period for Project X = 2 Years + ((Initial Investment-Cumulative Cash Flow at the Year 2)/Cashflow of Year 3] = 2Years + (10000 - 9500)/3000] = 2 Years + (500/3000) = 2 Years + 0.17 Year = 2.17 Years 20 21 22 23 24 25

A B D H 25 26 27 28 Payback Period for Project Y = 3 Year + ((Initial Investment-Cumulative Cash Flow at the Year 3y/Cashflow of Year 4] = 3 Year + [(10000 - 9000)/3000] = 3 Year + (1000 / 3000) = 3 Year + 0.33 Year = 3.33 Years 29 30 31 32 33 34 NPV Year 0 35 36 1 llo Project X -10,000 $ 6,500 $ 3,000 $ 3,000 $ 1,000 $ $ $ $ $ $ Project Y -10,000 3,000 3,000 3,000 3,000 2 3 4 Cost of Capital 12% 12% 37 38 39 40 41 42 43 44 45 46 Formula =C35+NPV(C41,C36:C39) =D35+NPV(D41,D36:D39) NPV $ 966.01 $ -887.95

A B D F G 46 47 IRR 48 Year 0 49 1 50 51 52 53 54 Project X -10,000 $ 6,500 $ 3,000 $ 3,000 $ 1,000 $ $ $ $ $ Project Y -10,000 3,000 3,000 3,000 3,000 2 3 4 55 Formula =IRR(C49:C53) =IRR(D49:053) 56 57 IRR 18.03% 7.71% 58 59 b) Project X should be selected as its NPV is positive than the Project Y. Project Y should not be selected as its NPV is negative. 60 61 62 63 64 65 66 67 68 69 70