# What are the cash flows assoicated with the project?

Great Lake 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 assoicated with the project?

b. What is the project’s IRR?

c. Assuming a project cost of capital of 10 percent, what is the projectect’s NPV?

d. What is the project’s MIRR?

14.5

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 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).

14.6

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:

Year—————–Expected Net 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 projects IRR? ITs MIRR?

15.1

The managers of Merton Medical Clinic are analyzing a proposed project. The project’s most likely NPV is \$120,000, but as evidenced by the following NPV distribution there is considerable risk involved:

Probability———-NPV

.05—————-(\$700,000)

.20—————–250,000

.50—————–120,000

.20——————200,000

.05——————300,000

a. What are the projects expected NPV and standard deviation of NPV?

b. Should the base case analysis use the most likely NPV or the expected NPV? Explian your answer.

15.2

Heywood Diagnostic Enterprises is evaluating a project with the following net cash flows and probabilities:

Year—-Prob= .2—Prob= .6——Prob= .2

0——–\$100,000–100,000—–100,000

1——-20,000—–30,000——–40,000

2——-20,000——30,000——-40,000

3——20,000——–30,000——-40,000

4——-20,000——–30,000——-40,000

5——-30,000———40,000——50,000

The year 5 values include salvage value. Heywood’s corporate cost of capital is 10 percent.

a. What is the projects expected (i.e., base case) NPV assuming average risk? (Hint: The base case net cash flows are the expected cash flows in each year.)

b. What are the projects mostly likely worst and the best case NPV’s?

c. What is the projects expected NPV on the basis of the scenario analysis?

d. What is the projects standard deviation of NPV?

e. Assume that Heywoods managers judge the project to have lower than average risk. Futhermore the companys policy is to adjust the corporate cost of capital up or down by 3 percent points to account for differential risk. Is the project financially attractive?

15.3 Consider the project contained in Problem 14.7 in chaper 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 hospitals staff concluded that the three most uncertain vribles were number of procedures per day, average collection amount, and the equipments salvage value. Futhermore the following data were developed:

Scenario-Probability-Number of -Averge–Equip.

-Procedures- Collection-Sal. Value

Worst—–.25——10———\$60——\$100,000

Most Likely–.50—-15——–\$80——-200,000

Best——-.25——-20——–\$100——300,000

c. Finally assume that California Health Center average project has a coefficent of variation of NPV in the range of 1.0-2.0. The hospital adjusts for risk by adding or substracting 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 hospitals manager?

15.4

The managers of United Medtronic are evaluating the following four projects for the coming budget period. The firms corporate cost of capital is 14 percent.

Project—-Cost———IRR

A———-\$15,000—-17%

B———-15,000——16

C———–12,000—–15

D————20,000—–13

a. What is the firm’s optimal capital budget?

b. Now, suppose Medtronics managers want to consider differential risk in the capital budgeting process. Project A has average risk, B has below average risk, C has above average risk and D has avaerage risk. What is the firms optimal capital budget when differential risk is considered?

(Hint : The firms managers lower the IRR of high risk projects by 3 percentage points and raise the IRR of low risk projects by the same amount.)