Assume that you are the chief financial officer at Porter Memorial Hospital. The
ID: 2470188 • Letter: A
Question
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 percent. The projects' expected net cash flows are:
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
Calculate each project's payback period, net present value (NPV), and internal rate of return (IRR).
Which project (or projects) is financially acceptable? Explain your answer.
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 percent. The projects' expected net cash flows are:
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
Calculate each project's payback period, net present value (NPV), and internal rate of return (IRR).
Which project (or projects) is financially acceptable? Explain your answer.
Explanation / Answer
Calculation of NPV of Project X:
Year CFAT D.F @ 12% PV OF Cash inflows
1 $6,500 0.8928 $5,803
2 3,000 0.7972 2,391
3 3,000 0.7118 2,135
4 1,000 0.6355 635
---------------
Present Value of Cash inflows $10,964
Less: Initial Investment 10,000
-----------------
NPV $964
----------------
Calculation of NPV of Project Y:
Year CFAT D.F @ 12% PV OF Cash inflows
1 $3,000 0.8928 $2,678
2 3,000 0.7972 2,391
3 3,000 0.7118 2,135
4 3,000 0.6355 1,906
---------------
Present Value of Cash inflows $10,964
Less: Initial Investment 9,110
-----------------
NPV ($890)
--------------------
Calculation of NPV of Project X:
Year CFAT D.F @ 17% PV OF Cash inflows
1 $6,500 0.8547 $5,555
2 3,000 0.7305 2,191
3 3,000 0.6244 1,873
4 1,000 0.5336 534
---------------
Present Value of Cash inflows $10,153
Less: Initial Investment 10,000
-----------------
NPV $153
----------------
Calculation of NPV of Project X:
Year CFAT D.F @ 18% PV OF Cash inflows
1 $6,500 0.8474 $5,508
2 3,000 0.7182 2,155
3 3,000 0.6086 1,826
4 1,000 0.5157 516
---------------
Present Value of Cash inflows $10,005
Less: Initial Investment 10,000
-----------------
NPV $5
----------------
IRR for project X= 18%
Calculation of IRR of Project Y when deiscount factor is 8%:
Year CFAT D.F @ 8% PV OF Cash inflows
1 $3,000 0.9259 $2,778
2 3,000 0.8,573 2,572
3 3,000 0.7938 2,381
4 3,000 0.7350 2,205
---------------
Present Value of Cash inflows $9,936
Less: Initial Investment 10,000
-----------------
NPV ($64)
----------------
Calculation of IRR of Project Y when discount factor is 7% :
Year CFAT D.F @ 7% PV OF Cash inflows
1 $3,000 0.9345 $2,803
2 3,000 0.8,734 2,620
3 3,000 0.8163 2,449
4 3,000 0.7629 2,289
---------------
Present Value of Cash inflows $10,161
Less: Initial Investment 10,000
-----------------
NPV $161
----------------
IRR= 7+
IRR= 7+
IRR for project Y= 7.71%
Project X can be accepted since it is generating an NPV greater than project Y. It can be also accepted by using IRR method also since it is generating 18% IRR.