years, the space will be James Polk Hospital has currently unused space in its l

Question

years, the space will be James Polk Hospital has currently unused space in its lobby. In three 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 walks through the lobby all day long. The hospital plans to purchase the franchise(s), operate it for three years, and then close 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 the health conscious and not so health conscious crowds without the franchises directl one another. The corporate cost of capital is 10 percent. y competing against Net cash flows Year Franchise L S100 S10 S60 $80 Franchise S $100 $70 $50 $20 0 19 a. Calculate each franchise's payback period, net present value (NPV), intemal rate of return (IRR), and modified internal rate of return (MIRR). b. Which project or projects should be accepted if they are independent? Which project should be accepted if they are mutually exclusive?

Explanation / Answer

Franchise S

NPV = Present value of cash inflows - Cash outflows

= 119.98-100 i.e 19.98

Payback period = 70(year 1) +30/50 ( Balance in year 2)

= Year 1 + 0.60 Year 2

= 1.60 years

NPV @ 25% = 70(PVF 25% , year 1) +50(PVF 25%,year 2) +20 (PVF 25%,year 3) -100

=- 1.80

Internal rate of return = 10%+10.68

= 20.68%

Franchise L

NPV = 118.77-100 i.e 18.77

Payback period = 10(Year1)+60(year 2) +Balance 30 ( Year 3)

= Year 1+Year 2 +30/80year 3

=2.375 years

Calculation of IRR

NPV @ 25% = 10(0.80)+60(0.64)+80(0.512)-100

= (12.64)

Internal rate of return = 10% +8.964%

   = 18.964%

Particulars Year Cash flow PVF @ 10% PV Initial investment 0 100 1 100 Cash inflow at year 1 1 70 0.9090 63.63 Cash inflow at year 2 2 50 0.8264 41.32 Cash inflow at year 3 3 20 0.7513 15.03

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