# capital budgeting

Assume that you are the chief financial officer at Porter Memorial Hospital. The CEO has asked you 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%. The project’s 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?

b. Calculate net present value (NPV)?

c. Calculate internal rate of return (IRR)?

d. Which project (or projects is financially acceptable?

e. Explain your answer.

15.3 Consider the project contained in Problem 14.7 in Chapter 14.

a. Perform a sensitivity analysis to see how NPV is affected by changes in the number of procedures per day, average collection amount, and salvage value.

b. Conduct a scenario analysis. Suppose that the hospital’s staff concluded that the three most uncertain variables were number of procedures per day, average collection amount, and the equipment’s salvage value. Furthermore, the following data were developed: Number of Average Equipment Scenario Probability Procedures Collection Salvage Value Worst 0.25 10 $ 60 $100,000Most likely 0.50 15 80 200,000Best 0.25 20 100 300,000

c. Finally, assume that California Health Center’s average project has a coefficient of variation of NPV in the range of 1.0-2.0. (Hint: Coefficient of variation is defined as the standard deviation of NPV divided by the expected NPV.) The hospital adjusts for risk by adding or subtracting 3 percentage points to its 10 percent corporate cost of capital. After adjusting for differential risk, is the project still profitable?

d. What type of risk was measured and accounted for in Parts b and c? Should this be of concern to the hospital’s managers?