Assume that you are the chief financial officer at Porter Memorial Hospital. The
ID: 2669616 • Letter: A
Question
Assume that you are the chief financial officer at Porter Memorial Hospital. The CEO has asked to 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 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
Question; Calculate each project’s payback period, net present value, and internal rate of return.
Explanation / Answer
Payback period : Payback period is the time required for cumulative cash inflows to recover the cash outflows of the project. Payback period (PBP) = Year before full recovery + (Unrecovered cost at start of year/Cash flow during year) Proj X : We have Initial Investmemt as 10,000 & annual CF as 6500,3000,3000,1000. So Payback period is in 3rd year as 6500+3000 = 9500 whcih is 500 short of Initial investment. ie PBP = 2+ 500/3000 = 2.17 yrs NPV of Proj X = NPV(Rate,CFs) + Initial Inv =NPV(12%,6500,3000,3000,1000) -10000 ie NPV of Proj X = $966.01 IRR for Proj X = IRR(CFs) = IRR(-10000,6500,3000,3000,1000) = 18.03% Proj Y : We have Initial Investmemt as 10,000 & annual CF as 3000,3000,3000,3000. As Cfs are all equal, PBP = Initial Inv/CF = 10000/3000 = 3.33 Yrs NPV of Proj Y = NPV(Rate,CFs) + Initial Inv =NPV(12%,3000,3000,3000,3000) -10000 ie NPV of Proj Y = $(887.95) IRR for Proj Y= IRR(CFs) = IRR(-10000,3000,3000,3000,3000) = 7.71% Based on NPV, Proj X should be chosen as it has Positive NPV