Question

Florida Hospital-Apopka is moving from its old location to a brand new complex. The hospital wants to build a modern parking garage in the new location. The building consultants estimate that, if the garage were constructed today, the capital cost would be $10,000,000. Since the hospital does not have the funds and they do not want to borrow more money, they decided to establish a building fund savings account so that they can accumulate the resources needed to pay for the parking garage in four (4) years. The building consultants estimate that constructions cost will increased by 3.0% per year over the next four years due to shortage of some materials and labor.

The hospital is considering two banks for the building fund. First, Bank of America offers a 4-year CD that pays a 5% interest rate compounded monthly. In this account, deposits can be made periodically but all funds must remain on deposit until the end of the four years. Second, Chace Bank offers a money market account that pays 4.8% compounded daily. In this account, all funds may be withdrawn at any time. The hospital projects that it will be able to invest $3,400,000 immediately, $2,900,000 in one year, and $1,900,000 in two years, and $1,800,000 in three years.

The hospital wants to ensure that it will have the funds it needs to build the parking garage, but it is also concerned about “locking up” its funds for four years (which the CD would require). Management must decide which bank to use for its building fund.

Part a: Estimate the cost of the facility four (4) years from now

Part b: Calculate the effective annual rate (EAR) of the investment at each bank

Part c: Calculate the ending amount in the building fund account if the hospital decides on the 4-year CD offered by Bank of America

Part d: Calculate the ending amount in the building fund account if the hospital decides on the money market account offered by Chase Bank.

Part e: You have been asked by the CFO to make a recommendation as to which option to choose. Please provide your recommendation and supporting arguments.

Answer 1