Question

You just got hired at a brand new hospital as a financial analyst and the Board wants to buy an MRI machine but they are unsure if this makes financial sense. You gather some figures so you can make an informed decision to present to the Board. (questions 40-44) Use CF’s given, no further calculation has to be done for CF’s.

Cost of the MRI machine 1.5 million

Salvage value after 5 years 50k

Working capital to hire an operator 200k only initially and not recoverable.

CF yr 1-3 400k

CF yr 4-5 300k

The hospital currently has no common stock or preferred stock or debt in their capital structure as it was funded with a 25 million dollar gift from Bill Gates. The machine is to be financed with a 5%, 5 year loan. Interest is tax deductible and the tax rate is 30%. ANSWERS IN EXCEL PLEASE

40. The IRR on this MRI machine is:

1. 4%
2. 3%
3. 7.7%
4. 6.8%

41. T/F Based on the IRR decision criteria we should accept this project

42. Based on the NPV analysis what should you recommend to the board

a. Do not recommend as it will take away 89k of value

b. Recommend as it will add 135k in value

c. Recommend as it will add 177k in value

d. Do not recommend as it will take away 23k of value

43. Assume now that the hospital was financed with 60% debt and 40% equity. The cost of debt is 6% and taxes are 20%, while the risk free rate is 3%, beta is .8 and the return of the market is 9%. If cash flow in years 1-3 are now assumed to increase to 500k instead of 400k, what would you recommend to the board?

a. Yes as it adds 136k in value

b. Yes as it adds 98k in value

c. no as the IRR<WACC

d. Yes as it adds 100k in value

44. T/F the payback under the original MRI assumptions is 4.67 years

Answer 1

40]

cash outflow in year 0 = cost of machine + working capital

cash inflow in year 5 = $300,000 + salvage value

IRR is calculated using IRR function in Excel

IRR is 3%

41]

False - based on the IRR, we should not accept the project. This is because IRR (3%) is less than the finance cost of the machine (5%)

42]

NPV is calculated using NPV function in Excel with 5% cost of capital

NPV is -$89,656

It is not recommended as it will take away 89k in value

43]

cost of capital = (weight of equity * cost of equity) + (weight of debt * cost of debt)

cost of equity = risk free rate + (beta * (market return - risk free rate)) = 3% + (0.8 * (9% - 3%)) = 7.8%

cost of debt = pretax cost of debt * (1 - tax rate) = 6% * (1 - 20%) = 4.8%

cost of capital = (60% * 7.8%) + (40% * 4.8%) = 6%

Now, we calculate NPV using 6% cost of capital. NPV is $135,674

It is recommended as it adds 135k in value