Suppose that you as the chief financial officer for Kindle Memorial Hospital and
ID: 2768538 • Letter: S
Question
Suppose that you as the chief financial officer for Kindle Memorial Hospital and you were asked by the CEO 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 projects’ expected net cash flows are as follows:
Year Project X Project Y
0 ($10,000) ($10,000)
1 6,500 3,000
2 3,000 3,000
3 3,000 3,000
4 1,000 3,000
a. Calculate each project’s payback period, net present value (NPV) and Internal rate of return (IRR)
b. Which project (or projects) is financially acceptable? Explain your answer briefly.
Explanation / Answer
a.
NPV of Project X = $966.01
NPV of Project Y = -$887.95
Pyback period of Project X = 2 + 500/3000 = 2.17 years
Payback period of Project Y = 3 + 1000/3000 = 3.33 years
IRR is that rate at which PV is equal to zero.
Trying out various rates in table above, we get:
IRR of project X = 18.03% (approx.)
IRR of project Y = 7.72% (approx.)
Project X should be acceptable. A project is acceptable only if its NPV is greater than zero. Since NPV of project Y is negative, it should be rejected. Also a project with lower payback period and higher IRR is considered better. Thus as compared to project Y, project X is acceptable in every way.
Year Project X Project Y PV Factor @ 12% PV of Project X PV of Project Y 0 -10000 -10000 1 -10000 -10000 1 6500 3000 0.8929 5803.57 2678.57 2 3000 3000 0.7972 2391.58 2391.58 3 3000 3000 0.7118 2135.34 2135.34 4 1000 3000 0.6355 635.52 1906.55 NPV 966.01 -887.95Related Questions
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