Finance Question
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chapter-11-problems.xls-workshop-4.xlsProblem 1
| UNDERSTANDING HEALTHCARE FINANCIAL MANAGEMENT | ||
| Chapter 11 -- The Basics of Capital Budgeting | ||
| PROBLEM 1 | ||
| Winston Clinic is evaluating a project that costs $52,125 and has expected net cash flows of $12,000 per | ||
| year for eight years. The first inflow occurs one year after the cost outflow, and the project has a cost of | ||
| capital of 12 percent. | ||
| a. What is the project's payback? | ||
| b. What is the project's NPV? Its IRR? | ||
| c. Is the project financially acceptable? Explain your answer. | ||
| ANSWER |
Problem 2
| UNDERSTANDING HEALTHCARE FINANCIAL MANAGEMENT | |||
| Chapter 11 -- The Basics of Capital Budgeting | |||
| PROBLEM 2 | |||
| Better Health, Inc. is evaluating two investment projects, each of which requires an up-front expenditure | |||
| of $1.5 million. The projects are expected to produce the following net cash inflows: | |||
| Year | Project A | Project B | |
| 0 | -$1,500,000 | -$1,500,000 | |
| 1 | $500,000 | $2,000,000 | |
| 2 | $1,000,000 | $1,000,000 | |
| 3 | $2,000,000 | $600,000 | |
| a. What is each project's IRR? | |||
| b. What is each project's NPV if the cost of capital is 10 percent? 5 percent? 15 percent? | |||
| ANSWER |
Problem 3
| UNDERSTANDING HEALTHCARE FINANCIAL MANAGEMENT | |||
| Chapter 11 -- The Basics of Capital Budgeting | |||
| PROBLEM 3 | |||
| Capitol Health Plans, Inc. is evaluating two different methods for providing home health services to its | |||
| members. Both methods involve contracting out for services, and the health outcomes and revenues are | |||
| not affected by the method chosen. Therefore, the incremental cash flows for the decision are all outflows. | |||
| Here are the projected flows: | |||
| Year | Method A | Method B | |
| 0 | -$300,000 | -$120,000 | |
| 1 | -$66,000 | -$96,000 | |
| 2 | -$66,000 | -$96,000 | |
| 3 | -$66,000 | -$96,000 | |
| 4 | -$66,000 | -$96,000 | |
| 5 | -$66,000 | -$96,000 | |
| a. What is each alternative's IRR? | |||
| b. If the cost of capital for both methods is 9 percent, which method should be chosen? Why? | |||
| ANSWER |
Problem 4
| UNDERSTANDING HEALTHCARE FINANCIAL MANAGEMENT | ||
| Chapter 11 -- The Basics of Capital Budgeting | ||
| PROBLEM 4 | ||
| Great Lakes Clinic has been asked to provide exclusive healthcare services for next year's World | ||
| Exposition. Although flattered by the request, the clinic's managers want to conduct a financial analysis | ||
| of the project. There will be an up-front cost of $160,000 to get the clinic in operation. Then, a net cash | ||
| inflow of $1 million is expected from operations in each of the two years of the exposition. However, the | ||
| clinic has to pay the organizers of the exposition a fee for the marketing value of the opportunity. This | ||
| fee, which must be paid at the end of the second year, is $2 million. | ||
| a. What are the cash flows associated with the project? | ||
| b. What is the project's IRR? | ||
| c. Assuming a project cost of capital of 10 percent, what is the project's NPV? | ||
| ANSWER |
Problem 5
| UNDERSTANDING HEALTHCARE FINANCIAL MANAGEMENT | |||
| Chapter 11 -- The Basics of Capital Budgeting | |||
| PROBLEM 5 | |||
| Assume that you are the CFO 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 percent. 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, net present value (NPV), and internal rate of return (IRR). | |||
| b. Which project (or projects) is financially acceptable? Explain your answer. | |||
| ANSWER |
Problem 6
| UNDERSTANDING HEALTHCARE FINANCIAL MANAGEMENT | ||
| Chapter 11 -- The Basics of Capital Budgeting | ||
| PROBLEM 6 | ||
| The director of capital budgeting for Big Sky Health Systems, Inc. has estimated the following cash flows | ||
| in thousands of dollars for a proposed new service: | ||
| Expected Net | ||
| Year | Cash Flow | |
| 0 | -100 | |
| 1 | 70 | |
| 2 | 50 | |
| 3 | 20 | |
| The project's cost of capital is 10 percent. | ||
| a. What is the project's payback period? | ||
| b. What is the project's NPV? | ||
| c. What is the project's IRR? | ||
| ANSWER |
Problem 7
| UNDERSTANDING HEALTHCARE FINANCIAL MANAGEMENT | ||||||||
| Chapter 11 -- The Basics of Capital Budgeting | ||||||||
| PROBLEM 7 | ||||||||
| California Health Center, a for-profit hospital, is evaluating the purchase of new diagnostic equipment. | ||||||||
| The equipment, which costs $600,000, has an expected life of five years and an estimated pre-tax salvage | ||||||||
| value of $200,000 at that time. The equipment is expected to be used 15 times a day for 250 days a year | ||||||||
| for each year of the project's life. On average, each procedure is expected to generate $80 in collections, | ||||||||
| which is net of bad debt losses and contractual allowances, in its first year of use. Thus, net revenues for | ||||||||
| Year 1 are estimated at 15 X 250 X $80 = $300,000. | ||||||||
| Labor and maintenance costs are expected to be $100,000 during the first year of operation, while utilities | ||||||||
| will cost another $10,000 and cash overhead will increase by $5,000 in Year 1. The cost for expendable | ||||||||
| supplies is expected to average $5 per procedure during the first year. All costs and revenues, except | ||||||||
| depreciation, are expected to increase at a 5 percent inflation rate after the first year. | ||||||||
| The equipment falls into the MACRS five-year class for tax depreciation and hence is subject to the | ||||||||
| following depreciation allowances: | ||||||||
| Year | Allowance | |||||||
| 1 | 0.2 | |||||||
| 2 | 0.32 | |||||||
| 3 | 0.19 | |||||||
| 4 | 0.12 | |||||||
| 5 | 0.11 | |||||||
| 6 | 0.06 | |||||||
| The hospital's tax rate is 40 percent, and its corporate cost of capital is 10 percent. | ||||||||
| a. Estimate the project's net cash flows over its five-year estimated life. | ||||||||
| b. What are the project's NPV and IRR? (Assume that the project has average risk.) | ||||||||
| (Hint: Use the following format as a guide.) | ||||||||
| Year | ||||||||
| 0 | 1 | 2 | 3 | 4 | 5 | |||
| Equipment cost | ||||||||
| Net revenues | ||||||||
| Less: | Labor/maintenance costs | |||||||
| Utilities costs | ||||||||
| Supplies | ||||||||
| Incremental overhead | ||||||||
| Depreciation | ||||||||
| Operating income | ||||||||
| Taxes | ||||||||
| Net operating income | ||||||||
| Plus: Depreciation | ||||||||
| Plus: After-tax equipment salvage value* | ||||||||
| Net cash flow | ||||||||
| * | ||||||||
| Pre-tax equipment salvage value | ||||||||
| MACRS equipment salvage value | ||||||||
| Difference | ||||||||
| Taxes | ||||||||
| After-tax equipment salvage value |
Problem 8
| UNDERSTANDING HEALTHCARE FINANCIAL MANAGEMENT | ||
| Chapter 11 -- The Basics of Capital Budgeting | ||
| PROBLEM 8 | ||
| You have been asked by the president and CEO of Kidd Pharmaceuticals to evaluate the proposed | ||
| acquisition of a new labeling machine for one of the firm's production lines. The machine's price is | ||
| $50,000, and it would cost another $10,000 for transportation and installation. The machine falls into the | ||
| MACRS three-year class, and hence the tax depreciation allowances are 0.33, 0.45, and 0.15 in Years 1, | ||
| 2, and 3, respectively. The machine would be sold after three years because the production line is being | ||
| closed at that time. The best estimate of the machine's salvage value after three years of use is $20,000. | ||
| The machine would have no effect on the firm's sales or revenues, but it is expected to save Kidd $20,000 | ||
| per year in before-tax operating costs. The firm's tax rate is 40 percent and its corporate cost of capital is | ||
| 10 percent. | ||
| a. What is the project's net investment outlay at Year 0? | ||
| b. What are the project's operating cash flows in Years 1, 2, and 3? | ||
| c. What are the terminal cash flows at the end of Year 3? | ||
| d. If the project has average risk, is it expected to be profitable? | ||
| ANSWER |
Problem 9
| UNDERSTANDING HEALTHCARE FINANCIAL MANAGEMENT | |||
| Chapter 11 -- The Basics of Capital Budgeting | |||
| PROBLEM 9 | |||
| The staff of Jefferson Memorial Hospital has estimated the following net cash flows for a satellite food | |||
| services operation that it may open in its outpatient clinic: | |||
| Expected Net | |||
| Year | Cash Flow | ||
| 0 | -$100,000 | ||
| 1 | $30,000 | ||
| 2 | $30,000 | ||
| 3 | $30,000 | ||
| 4 | $30,000 | ||
| 5 | $30,000 | ||
| 5 | Salvage value | $20,000 | |
| The Year 0 cash flow is the investment cost of the new food service, while the final amount is the | |||
| terminal cash flow. (The clinic is expected to move to a new building in five years.) All other flows | |||
| represent net operating cash flows. Jefferson's corporate cost of capital is 10 percent. | |||
| a. What is the project's IRR? | |||
| b. Assuming the project has average risk, what is its NPV? | |||
| c. Now, assume that the operating cash flows in Years 1 through 5 can be as low as $20,000 or as high as | |||
| $40,000. Furthermore, the salvage value cash flow at the end of Year 5 can be as low as $0 or as | |||
| high as $30,000. What is the worst case and best case IRR? The worst case and best case NPV? | |||
| ANSWER |
