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Chapter 12 Problem 3

Consider the project contained in Problem 7 in Chapter 11 (California Health Center).

a. Perform a sensitivity analysis to see how NPV is affected by changes in the number of procedures per day, average collection amount, and salvage value. Remember supplies vary with number of procedures.

Answer a).

Procedures per day.

Salvage Value change.Changing the Net Operating Income to include a salvage value of $100,000=$229,247.NPV=$38,290.35. To determine this, I changed the after tax equipment salvage value, using the pre tax amount, $100,000 + the MACRS value at year 5 ($36,0000)-40% tax($81,600) and plugged it into the equation above into an excel spreadsheet to determine the NPV

b. Conduct a scenario analysis. Suppose that the hospital’s staff concluded that the three most uncertain variables were number of procedures per day, average collection amount, and the equipment’s salvage value. Furthermore, the following data were developed:

Equipment

Number of

Average

Salvage

Scenario

Probability

Procedures

Collection

Value

Worst

0.25

10

$60

$100,000

Most likely

0.50

15

$80

$200,000

Best

0.25

20

$100

$300,000

c. Finally, assume that California Health Center’s average project has a coefficient of variation of NPV in the range of 1.0 – 2.0. (Hint: Coefficient of variation is defined as the standard deviation of NPV divided by the expected NPV.) The hospital adjusts for risk by adding or subtracting 3 percentage points to its 10 percent corporate cost of capital. After adjusting for differential risk, is the project still profitable?

d. What type of risk was measured and accounted for in Parts b. and c.? Should this be of concern to the hospital’s managers?

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