You just got hired at a brand new hospital as a financial analyst and the Board...

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Finance

You just got hired at a brand new hospital as a financialanalyst and the Board wants to buy an MRI machine but they areunsure if this makes financial sense. You gather some figures soyou can make an informed decision to present to the Board.(questions 40-44) Use CF’s given, no further calculation has to bedone 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 notrecoverable.
CF yr 1-3 400k
CF yr 4-5 300k
The hospital currently has no commonstock or preferred stock or debt in their capital structure as itwas funded with a 25 million dollar gift from Bill Gates. Themachine is to be financed with a 5%, 5 year loan. Interest is taxdeductible and the tax rate is 30%
Assume now that the hospital wasfinanced with 60% debt and 40% equity. The cost of debt is 6% andtaxes are 20%, while the risk free rate is 3%, beta is .8 and thereturn of the market is 9%. If cash flow in years 1-3 are nowassumed to increase to 500k instead of 400k, what would yourecommend to the board?
a. Yes as it adds 136k in value
b. Yes as it adds 98k in value
c. no as the IRR
d. Yes as it adds 100k in value
44. T/F the payback under the originalMRI assumptions is 4.67 years
MRI Cost 1,500,000.00 CF0 1 2 3 4 5 IRR 9.14%
SalvageValue 50,000.00 -1,700,000.00 500,000.00 500,000.00 500,000.00 300,000.00 350,000.00
WorkingCapital 200,000.00
CF Yr1-3 500,000.00
CF Yr4-5 300,000.00

Answer & Explanation Solved by verified expert

4.5 Ratings (1039 Votes)


	Tax Rate =20%=0.2
	Before tax cost of debt =6%
Cd	After tax Cost of debt =6*(1-0.2)	4.80%
	Required Return of equity
	R=Rf+Beta*(Rm-Rf)
	Rf=risk free rate=3%
	Beta=0.8
	Rm=Market return=9%
	R=3+0.8*(9-3)=	7.80%
Ce	Cost of equity	7.80%
Wd	Weight of debt in the capital	0.6
We	Weight of Equity in the capital	0.4
	Weighted Average Cost of Capital(WACC) =WdCd+WeCe
	WACC=0.64.8+0.47.8=	6.00%

	Present Value of Cash Flow
	(Cash Flow)/((1+i)^N)
	i=discount rate=WACC=6%=0.06
	N=Year of cash flow

N	Year	0	1	2	3	4	5
a	Initial cash flow	(1,700,000.00)
b	Annual Cash Flow		500,000.00	500,000.00	500,000.00	300,000.00	300,000.00
c	Salvage Value						50,000.00
d=a+b+c	Net Cash flow	(1,700,000.00)	500,000.00	500,000.00	500,000.00	300,000.00	350,000.00	SUM
PV=d/(1.06^N)	Present Value of net cash flow	(1,700,000.00)	471698.11	444998.22	419809.64	237628.10	261540.36	135,674.43
	Net Present Value =Sum of PVs	135,674.43

	Recommendation:
	a. Yes as it adds 136k in value

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Transcribed Image Text

You just got hired at a brand new hospital as a financialanalyst and the Board wants to buy an MRI machine but they areunsure if this makes financial sense. You gather some figures soyou can make an informed decision to present to the Board.(questions 40-44) Use CF’s given, no further calculation has to bedone for CF’s.Cost of the MRI machine 1.5 millionSalvage value after 5 years 50kWorking capital to hire an operator 200k only initially and notrecoverable.CF yr 1-3 400kCF yr 4-5 300kThe hospital currently has no commonstock or preferred stock or debt in their capital structure as itwas funded with a 25 million dollar gift from Bill Gates. Themachine is to be financed with a 5%, 5 year loan. Interest is taxdeductible and the tax rate is 30%Assume now that the hospital wasfinanced with 60% debt and 40% equity. The cost of debt is 6% andtaxes are 20%, while the risk free rate is 3%, beta is .8 and thereturn of the market is 9%. If cash flow in years 1-3 are nowassumed to increase to 500k instead of 400k, what would yourecommend to the board?a. Yes as it adds 136k in valueb. Yes as it adds 98k in valuec. no as the IRRd. Yes as it adds 100k in value44. T/F the payback under the originalMRI assumptions is 4.67 yearsMRI Cost1,500,000.00CF012345IRR9.14%SalvageValue50,000.00-1,700,000.00500,000.00500,000.00500,000.00300,000.00350,000.00WorkingCapital200,000.00CF Yr1-3500,000.00CF Yr4-5300,000.00

MRI Cost	1,500,000.00	CF0	1	2	3	4	5	IRR	9.14%
SalvageValue	50,000.00	-1,700,000.00	500,000.00	500,000.00	500,000.00	300,000.00	350,000.00
WorkingCapital	200,000.00
CF Yr1-3	500,000.00
CF Yr4-5	300,000.00