Calculate the expected rate of return on each alternative

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UNDERSTANDING HEALTHCARE FINANCIAL MANAGEMENT ASSIGNMENT

Part A-

Question 1 - Mini-Case: Time Value Analysis                    

John Adams is the CEO of a nursing home in San Jose. He is now 50 years old and plans to retire in ten years. He expects to live for 25 years after he retires-that is, until he is 85. He wants a fixed retirement income that has the same purchasing power at the time he retires as $40,000 has today (he realizes that the real value of his retirement income will decline year by year after he retires). His retirement income will begin the day he retires, ten years from today, and he will then get 24 additional annual payments. Inflation is expected to be 5 percent per year for ten years (ignore inflation after John retires); he currently has $100,000 saved up; and he expects to earn a return on his savings of 8 percent per year, annual compounding. To the nearest dollar, how much must he save during each of the next ten years (with deposits being made at the end of each year) to meet his retirement goal? (Hint: The inflation rate 5 percent per year is used only to calculate desired retirement income.)

Question 2 - Mini-Case: Financial Risk and Required Return                                                      

Assume that you recently graduated and you just landed a job as a financial planner with the Cleveland Clinic. Your first assignment is to invest $100,000. Because the funds are to be invested at the end of one year, you have been instructed to plan for a one-year holding period. Further, your boss has restricted you to the following investment alternatives, shown with their probabilities and associated outcomes.

State of Economy

Probability

T-Bills

Alta Inds.

Repo Men

American Foam

Market Port.

Recession

0.1

8.00%

-22.0%

28.0%

10.0%

-13.0%

Below Average

0.2

8.00%

-2.0%

14.7%

-10.0%

1.0%

Average

0.4

8.00%

20.0%

0.0%

7.0%

15.0%

Above Average

0.2

8.00%

35.0%

-10.0%

45.0%

29.0%

Boom

0.1

8.00%

50.0%

-20.0%

30.0%

43.0%

Barney Smith Investment Advisors recently issued estimates for the state of the economy and the rate of return on each state of the economy. Alta Industries, Inc. is an electronics firm; Repo Men Inc. collects past due debts; and American Foam manufactures mattresses and various other foam products. Barney Smith also maintains an "index fund" which owns a market-weighted fraction of all publicly traded stocks; you can invest in that fund and thus obtain average stock market results. Given the situation as described, answer the following questions.

a. Calculate the expected rate of return on each alternative.

b. Calculate the standard deviation of returns on each alternative.

c. Calculate the coefficient of variation on each alternative.

d. Calculate the beta on each alternative.

e. Do the SD, CV, and beta produce the same risk ranking? Why or why not?

f. Suppose you create a two-stock portfolio by investing $50,000 in Alta Industries and $50,000 in Repo Men. Calculate the expected return, standard deviation, coefficient of variation, and beta for this portfolio. How does the risk of this two-stock portfolio compare with the risk of the individual stocks if they were held in isolation?

Question 3 - Mini-Case:  Debt Financing              

Sam Strother and Shawna Tibbs are vice presidents of Mutual of Seattle Group Health Cooperative and codirectors of the organization's pension fund management division. The unions that represent the GHC hospital staff have requested an investment seminar so that they better understand the decisions being made on behalf of their members. Strother and Tibbs, who will make the actual presentation, have asked you to help them by answering the following questions.

a. What is the value of a ten-year, $1,000 par value bond with a 10 percent annual coupon if its required rate of return is 10 percent?                                                                                                                             

b. What would be the value of the bond described in question a. if, just after it had been issued, the expected inflation rate rose by 3 percentage points, causing investors to require a 13 percent return? Would we now have a discount or a premium bond?

c. What would be the value of the bond described in question a. if, just after it had been issued, the expected inflation rate fell by 3 percentage points, causing investors to require a 7 percent return? Would we now have a discount or a premium bond?

d. What would happen to the value of the ten-year bond over time if the required rate of return remained at 13 percent, remained at 7 percent, or remained at 10 percent? Graph your results using the table below:


Value of Bond in Given Year:

N

7%

10%

13%

0

 

 

 

1

 

 

 

2

 

 

 

3

 

 

 

4

 

 

 

5

 

 

 

6

 

 

 

7

 

 

 

8

 

 

 

9

 

 

 

10

 

 

 

e. What is the yield to maturity on a ten-year, 9 percent annual coupon, $1,000 par value bond that sells for $887.00?

f. What are the total return, the current yield, and the capital gains yield for the bond in question e.?  (Assume the bond is held to maturity and the company does not default on the bond.)

Part B-

Question 1 - Mini Case: Lease Financing

Lewis Health System Inc. has decided to acquire a new electronic health record system for its Richmond hospital. The system receives clinical data and other patient information from nursing units and other patient care areas, and then either displays the information on a screen or stores it for later retrieval by physicians. The system also permits patients to call up their health record on Lewis's website.

The equipment costs $1,000,000, and, if it were purchased, Lewis could obtain a term loan for the full purchase price at a 10 percent interest rate. Although the equipment has a six-year useful life, it is classified as a special-purpose computer, so it falls into the MACRS three-year class. If the system were purchased, a four-year maintenance contract could be obtained at a cost of $20,000 per year, payable at the beginning of each year. The equipment would be sold after four years, and the best estimate of its residual value at that time is $200,000. However, since real-time display system technology is changing rapidly, the actual residual value is uncertain.

As an alternative to the borrow-and-buy plan, the equipment manufacturer informed Lewis that Consolidated Leasing would be willing to write a four-year guideline lease on the equipment, including maintenance, for payments of $260,000 at the beginning of each year. Lewis's marginal federal-plus-state tax rate is 40 percent. You have been asked to analyze the lease-versus-purchase decision, and in the process to answer the following questions:

a. What is the present value cost of owning the equipment?

b. What is the present value cost of leasing the equipment?

c. What is the net advantage to leasing (NAL)?

d. Answer these questions one at a time to see the effect of the change on NAL. That is, starting with the original numbers you used for questions a. and b., what is the NAL if:

- interest rate increases to 12 percent

- the tax rate falls to 34 percent

- maintenance cost increases to $25,000 per year

- residual value falls to $150,000

- the system price increases to $1,050,000

e. Do the changes in d. make leasing more or less attractive? Explain.

Question 2 - Mini Case: Capital Budgeting

James Polk Hospital has currently unused space in its lobby. In three years, the space will be required for a planned expansion, but the hospital is considering uses of the space until then. The hospital has decided that it wants to purchase at least one and maybe two fast food franchises, to take advantage of the high volume of patients and visitors that walk through the lobby all day long. The hospital plans to purchase the franchise(s), operate them for three years, and then close them down. The hospital has narrowed its selection down to two choices:

Franchise L: Lisa's Soups, Salads, and Stuff

Franchise S: Sam's Wonderful Fried Chicken

The net cash flows shown below include the costs of closing down the franchises in Year 3 and the forecast of how each franchise will do over the three-year period. Franchise L serves breakfast and lunch, while Franchise S serves only dinner, so it is possible for the hospital to invest in both franchises. The hospital believes these franchises are perfect complements to one another: The hospital could attract both the breakfast/lunch and dinner crowds and both the health-conscious and not-so-health-conscious crowds without the franchises directly competing against one another. The corporate cost of capital is 10 percent.


     Net cash flows

Year

Franchise S

Franchise L

0

-$100

-$100

1

$70

$10

2

$50

$60

3

$20

$80

a. Calculate each franchise's payback period, net present value (NPV), internal rate of return (IRR), and modified internal rate of return (MIRR).                                                                                                                   

b. Graph the NPV of each franchise at different values of the corporate cost of capital from 0 to 24 percent in 2 percent increments.                                                                                                                       

- How sensitive are the franchise NPVs to the corporate cost of capital?

- Why do the franchise NPVs differ in their sensitivity to the corporate cost of capital?

- At what cost of capital does each franchise intersect the X-axis? What are these values?

c. Which project or projects should be accepted if they are independent? Which project should be accepted if they are mutually exclusive?                                                                                                                       

d. Suppose the hospital could sell off the equipment for each franchise at the end of any year. Use NPV to determine the optimal economic life of each franchise when the salvage values are as follows:               


     Salvage value

Year

Franchise S

Franchise L

0

$100

$100

1

$60

$70

2

$20

$30

3

$0

$0

Question 3 - Mini Case: Financial Condition Analysis

Donna Jamison, a recent UNC graduate with four years of for-profit health management experience, was recently brought in as assistant to the chairman of the board of Computron Diagnostics, a manufacturer of clinical diagnostic equipment. The company had doubled its plant capacity, opened new sales offices outside its home territory, and launched an expensive advertising campaign. Computron's results were not satisfactory, to put it mildly. Its board of directors, which consisted of its president and vice president plus its major stockholders (who were all local business people), was most upset when directors learned how the expansion was going. Suppliers were being paid late and were unhappy, and the bank was complaining about the cut off credit. As a result, Al Watkins, Computron's president, was informed that changes would have to be made, and quickly, or he would be fired. Also, at the board's insistence, Donna Jamison was brought in and given the job of assistant to Fred Campo, a retired banker who was Computron's chairman and largest stockholder. Campo agreed to give up a few of his golfing days and help nurse the company back to health, with Jamison's assistance.

 Jamison began by gathering financial statements and other data, shown below. The data show the dire situation that Computron Diagnostics was in after the expansion program. Thus far, sales have not been up to the forecasted level, costs have been higher than were projected, and a large loss occurred in Year 2, rather than the expected profit. Jamison examined monthly data for Year 2 (not given in the case), and she detected an improving pattern during the year. Monthly sales were rising, costs were falling, and large losses in the early months had turned to a small profit by December. Thus, the annual data look somewhat worse than final monthly data. Also, it appears to be taking longer for the advertising program to get the message across, for the new sales offices to generate sales, and for the new manufacturing facilities to operate efficiently. In other words, the lags between spending money and deriving benefits were longer than Computron's managers had anticipated. For these reasons, Jamison and Campo see hope for the company-provided it can survive in the short run.  Jamison must prepare an analysis of where the company is now, what it must do to regain its financial health, and what actions should be taken.

Attachment:- PartB-Q3.rar

Reference no: EM131183432

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