Letterman Hospital expects Projects A and B to generate the following cash flows

Question

Letterman Hospital expects Projects A and B to generate the following cash flows: 13. Givens (in thousands) Years 0 1 Initial investment 2 Net operating cash flows for Project A 3 Net operating cash flows for Project B 4 Discount rate for Part a 5 Discount rate for Part b ($2,500) $1,800 $1,600 $900 $400 $200 $200 $400 $900 $1,600 $1,800 15% 5% a. Determine the NPV for both projects using a cost of capital of 15 percent. b. Determine the NPV for both projects using a cost of capital of 5 percent. c. At a 5 percent cost of capital, which project should be accepted? At a 15 percent cost of capital, which project should be accepted? Explain.

Explanation / Answer

Solution: a. The NPV for both projects using a cost of capital of 15 percent NPV $ Project A 1194.95 Project B 377.86 Working Notes: Year PVF @ 15% Project A cash flows Present value for A Cash flow Project B cash flows Present value for B Cash flow 0 1 -2500 -2500 -2500 -2500 1 0.869565217 1800 1565.22 200 173.91 2 0.756143667 1600 1209.83 400 302.46 3 0.657516232 900 591.76 900 591.76 4 0.571753246 400 228.70 1600 914.81 5 0.497176735 200 99.44 1800 894.92 NPV for project A 1194.95 NPV for project B 377.86 PVF @   15% for nth period is calculated by = 1/(1+i)^n = 1/(1.15)^n b. The NPV for both projects using a cost of capital of 5 percent NPV $ Project A 1928.77 Project B 1557.41 Working Notes: Year PVF @ 5% Project A cash flows Present value for A Cash flow Project B cash flows Present value for B Cash flow 0 1 -2500 -2500 -2500 -2500 1 0.952380952 1800 1714.29 200 190.48 2 0.907029478 1600 1451.25 400 362.81 3 0.863837599 900 777.45 900 777.45 4 0.822702475 400 329.08 1600 1316.32 5 0.783526166 200 156.71 1800 1410.35 NPV for project A 1928.77 NPV for project B 1557.41 PVF @   5% for nth period is calculated by = 1/(1+i)^n = 1/(1.05)^n c. At both 5% & 15% cost of capital , Project A should be selected as it have higher positive NPV than Project B at both the cost of capital rates. And At initial years of projects Project A have higher cash flow in comparison to Project B which will result recovery of initial cost in lesser period in project A than Project B . Please feel free to ask if anything about above solution in comment section of the question.

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