Rashid Hospital in UAF- received money for cancer research. The hospital is deci
ID: 2737818 • Letter: R
Question
Rashid Hospital in UAF- received money for cancer research. The hospital is deciding whether to use the money to invest in bank or to build a new research center. If the money is put into the bank, the bank would give research money to students to study medicine in local universities which would total to $9.75 million per year with 1st payment at the end of next year and continue each year indefinitely. OR, the money can be used to build an integrative cancer research center, the construction of the center will cost $I6.5 million and the center is expected to be renovated every 10 years at a cost of $3.3 million. The annual maintenance costs are expected to be $1 million per year. If the facility is expected to last forever, which alternative should be selected at an interest rate of 2% per year. Use Capitalized Costs (or Capitalized Worth) to evaluate each alternative. Calculate the Capitalized Costs for each option and select which one should be chosen.Explanation / Answer
Answer:
Capitalized cost under option 1:
Value of a perpetuity = Amount to be received at the end of each year / annualized interest rate
= $ 9.75 million / .02
= $ 487.50 million
This is the capitalized cost at the beginning of next year. We need to calculate capitalized cost now which would be
= $ 487.50 million / 1.02 = $ 477.94 million (Capitalized cost under option 1)
Capitalized cost under option 2:
First of all we need to calculate annualized equivalent amount for $ 3.3 million which is to be incurred every 10th year.
Present value of $ 3.3 million to be incurred every 10th year = $ 3.3 million / (1.02)^10 = $ 2.71 million
Annualized equivalent amount for $ 2.71 million for 10 years @ 2% rate p.a.
2.71 =Annualized equivalent amount * (1- (1+rate)^-n) / rate
2.71 = Annualized equivalent amount * (1- (1+.02)^-10) / .02
Annualized equivalent amount = $ 0.302 million
Total capitalized cost under option 2 = Construction cost + ( (Annualized equivalent amount + Annual maintenance)/ .02)
= $ 16.5 million + (($ 0.302 million + $ 1 million)/.02)
= $ 16.5 million + $ 65.10 million
= $ 81.60 million(Capitalized cost under option 2)
First option is to be chosen as it has higher capitalized costs.
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