Question

1. Assume that you are the chief financial officer at Porter Memorial Hospital. The CEO has asked you to analyze the 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 project’s 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

1. Calculate each project’s payback period and net present value.
2. Which project (s) is financially acceptable? Explain your answer.

Please include the input that would be used in a financial calculator if it is needed.

Answer 1

Year	0	1	2	3	4
Project X	-10,000	6,500	3,000	3,000	1,000
Cumlative cash flows	-3,500	-500	2,500	3,500
Payback Period	2.2 years
NPV @12%	966
Project Y	-10000	3000	3000	3000	3000
Cumlative cash flows	-7,000	-4,000	-1,000	2,000
Payback Period	3.3 years
NPV @12%	-888

a)The above table shows the payback period and NPV of the two projects.

Payback period is defined as the time required to recover the funds invested in an investment, or to reach a break-even point

The NPV (net present value) is applied to a series of cash flows which occur at different time. The PV of a cash-flows depend on the time interval between now (year 0) and the cash flow. It also depends on the assumed discount rate.

In excel we can use NPV formula to calculate NPV directly.

For a financial calculator we can assume the period as 4, cashflows as they are given for each period and discount rate as 12%

In our problem payback period is calculated as the sum of years till the time the initial investment is equal to the cumlative cashflows. For Project X the payback period is 2.2 as the investment is recovered in between year three. Here the 0.2 is 500/3000--> 500 is the cumlative cashflow at end of year 2 and 3000s is the cash flow in year 3. This the divison of the two will give us the fraction of the time in year 3 when the investment will be recovered.

b) Project X is financially acceptable as it has a higher NPV and lower payback period compared to Project Y

Please reach out to me in case of any clarification. Happy to help!