Assume that you are the chief financial officer at Porter Memorial Hospital. The
ID: 2612772 • 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 opportunity 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
Calculate each project’s payback, NPV, and IRR
Which project (or projects) is financially acceptable?Explain your answer.
Explanation / Answer
Answer: PAyback Period:
Project P
Rs. 10000 is covered in 3rd year, therefore, payback period is:
= 2 years + (12 months/3000) x 500
= 2 year and 2 months
Project Q
Rs. 10000 is covered in 4th year, therefore, payback period is:
= 3 years + (12 months x 3000) x 1000
= 3 year and 4 months
=3.4 years
Answer: Calculation of NPV:
Answer: Calculation of IRR:
Only project X is acceptable because it earns better than the other opportunities that compete for limited financial resources (that can generate the 12%).
Year P.V.F (12%) Project X Project Y PV (X) PV (Y) 0 1 -10000 -10000 -10000 -10000 1 0.893 6500 3000 5804.5 2679 2 0.797 3000 3000 2391 2391 3 0.712 3000 3000 2136 2136 4 0.636 1000 3000 636 1908 NPV 967.5 -886