You work for a small, local healthcare provider. In five years, the organization

Question

You work for a small, local healthcare provider. In five years, the organization plans to undertake a major upgrade to its servers and other IT infrastructure. Management estimates that it will need up to $450,000 to cover all related costs; however, as a growing organization, the goal is to pay for the upgrade with cash and not to take out loans Right now, you have $300,000 in a bank account established for Capital Investments. This account pays 6% interest, compounded annually A member of the finance department has approached you with an investment opportunity for the S300,000 that covers a five-year period and has the following projected after-tax cash flows: Year: Projected Cash Flow 1. $94,000 2. $114,000 3. $134,000 4. $114,000 5. $94,000 Based on this information, answer the following questions 1. How much money will be in the bank account if you leave the $300,000 alone until you need it in five years? 2. If you undertake the investment opportunity, what is the Nominal Payback Period? 3 Using the factors for 690, what is the Discounted Payback Period? 4. What is the Net Present Value of this investment opportunity? 5. Which option-make the investment or leave the money in a savings account-would you recommend to your CEO? Why? What additional factorsinformation might make you change your point of view? References

Explanation / Answer

1. The amount that will be in the bank if the amount is not invested otherwise =300,000 x 1.06^5 =300,000*1.3382 401460 Interest earned = $401,460 - $300,000 = $101,460. 2. Nominal payback for period for the investment project Year Cash flow Cum. cash flow 0 -300000 -300000 1 94000 -206000 2 114000 -92000 3 134000 42000 4 114000 156000 5 94000 250000 Nominal payback period is the third year The correct payback period = 2 + (92,000 / 134,000)               =2.69 years 3. Discounted payback for period for the investment project Year Cash flow Disc.factor Discounted Cum. @6% cash flow Cash flow 0 -300000 1.0000 -300000 -300000 1 94000 0.9434 88679 -211321 2 114000 0.8900 101460 -109861 3 134000 0.8396 112509 2648 4 114000 0.7921 90299 92947 5 94000 0.7473 70242 163189 Discounted payback period is the third year The correct payback period = 2 + (109,861 / 112,509)               =2.98 years 4. Net Present Value Year Cash flow Disc.factor Present @6% Value 0 -300000 1.0000 -300000 1 94000 0.9434 88679 2 114000 0.8900 101460 3 134000 0.8396 112509 4 114000 0.7921 90299 5 94000 0.7473 70242 Net Present Value 163189 5. The investment proposal shall be accepted, because       (i) The total return from the proposal is more than the              the return from the savings accounts ($250,000 compared to $101,460.       (ii) The present value of the project is positive and the payback period               is also 3 years.

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