Question

Your hospital is considering a new clinic. The clinic is expected to generate the cash flows shown below. Answer the following questions. (20 points)

1. What is the return expected on this investment measured in dollar terms if the     opportunity cost rate is 10 percent?      2. Provide an explanation, in economic terms, of your answer. 3. What is the return on this investment measured in percentage terms? 4. Should this investment be made? Explain your answer.

Year Start (1,000)

Year 1 250

Year 2 400

Year 3 500

Year 4 600

Answer 1

(1)

Return on dollar terms = Present worth (PW)

PW ($) = -1,000 + 250 x P/F(10%, 1) + 400 x P/F(10%, 2) + 500 x P/F(10%, 3) + 600 x P/F(10%, 4)

= -1,000 + 250 x 0.9091** + 400 x 0.8264** + 500 x 0.7513** + 600 x 0.6830**

= -1,000 + 227.28 + 330.56 + 375.65 + 409.8

= 343.29

(2)

It means that the discounted value of all future cash flows will be higher than current investment, so the project is acceptable.

(3)

Rate of Return (ROR) is computed using Excel IRR function as follows.

Year	Cash Flow ($)
0	-1,000
1	250
2	400
3	500
4	600
ROR =	22.93%

ROR = 22.93%

(4)

Since ROR is higher than opportunity cost (22.93% > 10%), the project should be accepted.