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Captial budgeting

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Happy Valley is considering moving from its present location into a new 200-bed facility. The estimated construction cost for the new facility is $40 million. The hospital has no internal funds and is considering a 20-year mortgage with interest scheduled to be eight percent. The issue will be repaid over 20 years with equal annual principal payments of $2 million. Interest expense would decline each year by $160,000.

The cost of the plant and fixed equipment would be 80 percent of the total cost or $32 million, and the movable equipment would be $8 million. The movable equipment would need to be replaced in ten years, and it is estimated that the replacement cost would be $17,271,200 (inflation is assumed to be eight percent per year). The plant and fixed equipment would need to be replaced in 30 years at a cost of $322,006,400 (inflation again assumed to be eight percent per year). All costs reflect only the investment required to provide inpatient services. A separate analysis will be done for outpatient services.

Happy Valley anticipates that its operation will generate about 9700 discharges per year. The hospital anticipates that its operating costs, excluding capital costs, will be $4,000 per discharge, or $38,800,000 in the first full year of operation.

The payer mix at Happy Valley is expected to be 60 percent Medicare and Medicaid on the inpatient side. These payers will pay approximately $4,400 per discharge. This payment reflects both operating and capital cost payments. Approximately ten percent of Happy Valleyâ??s operating and capital costs will be paid by payers who reimburse the hospital on a cost-related basis for both capital and operating costs. The remaining 30 percent of Happy Valleyâ??s business will be charge-based, but it is expected that discounts to commercial insurers and bad debt and charity write-offs will average 30 percent.

Assuming that Happy Valley wishes to break even on a cash-flow basis during the first year of operation, what charge per discharge must be set? If the hospital wanted to include an element in its rate structure to reflect replacement cost of the building and movable equipment, what additional amount would that be? Assume that 50 percent of the movable equipment cost would be debt financed and 80 percent of the building and fixed equipment would be debt financed. Also assume that the hospital can earn ten percent
on any invested money, so use ten percent as your discount rate.

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Solution Summary

Captial budgeting is exemplified.

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See Also This Related BrainMass Solution

Cost of Capital, Capital Budgeting, Capital Structure, Forecasting, and Working Capital Management

Please see attachment use word or excel but please show how you got the answer.

Question 1: (Cost of Capital)

You are provided the following information on a company. The total market value is $38 million. The company's capital structure, shown here, is considered to be optimal.
(see attached file for data)

a. What is the after-tax cost of debt? (assume the company's effective tax rate = 40%)
b. Assuming a $4 dividend paid annually, what is the required return for preferred shareholders (i.e. component cost of preferred stock)? (assume floatation costs = $0.00)
c. Assuming the risk-free rate is 1%, the expected return on the stock market is 7%, and the company's beta is 1.0, what is the required return for common stockholders (i.e., component cost of common stock)?
d. What is the company's weighted average cost of capital (WACC)?

Question 2: (Capital Budgeting)

It's time to decide how to use the money your firm is expected to make this year. Two investment opportunities are available, with net cash flows as follows:
(See attached file for data)

a. Calculate each project's Net Present Value (NPV), assuming your firm's weighted average cost of capital (WACC) is 7%
b. Calculate each project's Internal rate of Return (IRR).
c. Plot NPV profiles for both projects on a graph).
d. Assuming that your firm's WACC is 7%:
(1) If the projects are independent which one(s) should be accepted?
(2) If the projects are mutually exclusive which one(s) should be accepted?

Question 3: (Capital Structure)

Aaron Athletics is trying to determine its optimal capital structure. The company's capital structure consists of debt and common stock. In order to estimate the cost of debt, the company has produced the following table:
(See attached file for data)

The company's tax rate, T, is 40 percent. The company uses the CAPM to estimate its cost of common equity, Rs. The risk-free rate is 1 percent and the market risk premium is 6 percent. Aaron estimates that if it had no debt its beta would be 1.0. (i.e., its "unlevered beta," bU, equals 1.0.)

On the basis of this information, what is the company's optimal capital structure, and what is the firm's cost of capital at this optimal capital structure?

Question 4: (Forecasting)

A firm has the following balance sheet:
(See attached file for data)

Sales for the year just ended were $6,000, and fixed assets were used at 80 percent of capacity. Current assets and accounts payable vary directly with sales. Sales are expected to grow by 20 percent next year, the expected net profit margin is 5 percent, and the dividend payout ratio is 80 percent.

How much additional funds (AFN) will be needed next year, if any?

Question 5: Working Capital Management

The Chickman Corporation has an inventory conversion period of 60 days, a receivables collection period of 30 days, and a payables deferral period of 30 days. Its annual credit sales are $6,000,000, and its annual cost of goods sold (COGS) is 60% of sales.

a. What is the length of the firm's cash conversion cycle?
b. What is the firm's investment in accounts receivable?
c. What is the company's inventory turnover ratio?
d. Identify three ways in which the company could reduce its cash conversion cycle?
e. What are the possible risks of reducing the cash conversion cycle per your recommendations in part d?

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