Financial Analysis-PEMBA & Healthcare

Spring 2018

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1. MCG Drugs is considering the purchase of a new machine which will reduce manufacturing costs of $5,000
annually and increase earnings before depreciation and taxes by $6,000 annually. MCG will use the
MACRS accelerated method to depreciate the machine, and it expects to sell the machine at the end of its
5-year operating life for $10,000 (before taxes). MCG’s marginal tax rate is 40 percent, and it uses a 9
percent cost of capital to evaluate projects of this type. If the machine’s cost is $40,000, what is the project’s
NPV? Show all work and a spreadsheet showing the yearly cash flows. Go back and watch the videos if
you have trouble!

2. Alabama Diagnostics (ADC) is considering acquisition of new diagnostic equipment and they have two
choices: "Project Old Tech" or "Project New Tech." Both will do the job, but the actual costs involved with
Project New Tech, which uses unproved, new state-of-the-art technology, could be much higher than the
expected cost levels. The cash outflows associated with Project Old Tech, which uses standard proven
technology, are less risky--they are about as uncertain as the cash flows associated with an average project.
ADC's required rate of return for average risk projects normally is set at 12 percent, and the company adds
3 percent for high risk projects but subtracts 3 percent for low risk projects. The two projects in question
meet the criteria for high and average risk, but the financial manager is concerned about applying the
normal rule to such cost-only projects. You must decide which project to recommend, and you should
recommend the one with the lower PV of costs. What is the PV of costs of the better project? (Hint: The
cash flows are all costs (outflows) so remember how to adjust for risk given that they are all outflows)

Cash Outflows
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Years: 0 1 2 3 4
Project New Tech 1,500 315 315 315 315
Project Old Tech 600 600 600 600 600

3. Healthcare Corporation has been presented with an investment opportunity which will yield end-of-year
cash flows of $30,000 per year in Years 1 through 4, $35,000 per year in Years 5 through 9, and
$40,000 in Year 10. This investment will cost the firm $150,000 today, and the firm's cost of capital is 10
percent. What is the NPV for this investment?

4. The capital budgeting director of Sparrow Corporation is evaluating a project which costs $200,000, is
expected to last for 10 years and produce after-tax cash flows, including depreciation, of $44,503 per year.
If the firm's required rate of return is 14 percent and its tax rate is 40 percent, what is the project's IRR?
What is the MIRR? Why do some prefer the MIRR?

5. Excel Diagnostics is considering whether to lease or buy some specialized equipment to be placed in
service at their facility. The net cash flows associated with owning the equipment are as follows. The initial
purchase price is $1,000,000; the net cash inflows (after-tax considerations) in Years 1 through 5 are: Year
1 = $104,000; Year 2 = $152,000; Year 3 = $100,000; Year 4 = $72,000; Year 5 = $128,000. The lease
agreement calls for five beginning of year payments. The net cash outflow of each payment (after-tax
considerations) is $137,750. Compare the present values of the two alternatives using the relevant after-
tax discount rate of 8.0 percent. What is the net advantage to leasing the equipment?
6. Austin Healthcare. has the following balance sheet as of December 31, 2017.

Assets: Claims:
Current assets $ 600,000 Accounts payable $ 100,000
Fixed assets 400,000 Accruals 100,000
Notes payable 100,000
Total current liabilities $ 300,000

Long-term debt 300,000

Total equity 400,000
Total assets $1,000,000 Total claims $1,000,000

In 2017, the company also reported sales of $5 million, net income of $100,000, and dividends of
$60,000. The company anticipates its sales will increase 20 percent in 2018 and its dividend payout will
remain at 60 percent. Assume the company is at full capacity, so its assets and spontaneous liabilities
will increase proportionately with an increase in sales.

Assume the company uses the AFN formula and all additional funds needed (AFN) will come from
issuing new long-term debt. Given its forecast, how much long-term debt will the company have to issue
in 2018?

7. Empire Medical Products Inc. has annual sales of $90,000,000 and keeps average inventory of
$30,000,000. On average, the firm has accounts receivable of $20,000,000. The firm buys all raw
materials on credit, its trade credit terms are net 35 days, and it pays on time. The firm’s managers are
searching for ways to shorten the cash conversion cycle. If sales can be maintained at existing levels but
inventory can be lowered by $5,000,000 and accounts receivable lowered by $2,000,000, what will be the
net change in the cash conversion cycle? Use a 365-day year. Round to the closest whole day. Explain
what this means for the organization!

8. Why would a firm ever invest in a project that has an NPV=0 or would they? Explain what it means if the
NPV=0.

9. Discuss how one may effectively manage the cash conversion cycle in a healthcare organization such as
a hospital, clinic, etc. Be specific as to strategies for effective management. What is likely the most
important component of the cash conversion cycle for healthcare organizations?

10. We have done a number of problems regarding financial forecasting where the end goal is to determine
the long run financial needs of the organization. Thinking back to those problems, discuss the potential
sources for such long run funding needs. That is, suppose you determine additional funds are
indeed necessary to support future growth. Discuss in the context of a healthcare organization where
one may seek such funds and any difficulty you envision in securing such funds. Assume that you are
part of a reasonably large not for profit hospital organization. So for a capital investment project, what
would be your sources of funding?

11. You are to actually develop your own question to ask here. That is, as you reflect back on the course
material, think of a question you feel is important to ask but that was not asked on these questions. And
then you should develop your own answer. In other words, think of some area that you deem important and
then prepare a question and answer it. Please take this seriously and give thought to it.