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Northern Arizona University *

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Finance

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Apr 3, 2024

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docx

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Uploaded by DoctorOtterPerson4041

Read the following scenarios and calculate your answers using the ROI Cost of Capital Excel spreadsheet. 1. In 20XX, Olentangy Health Care’s (OHC) cost of capital was 6%. Its investments are $80,000 on a historical cost valuation basis, $100,000 on a replacement cost basis, and $110,000 on a current market value basis. If you were on OHC’s board, what minimum level of annual cash flow would you require in order to continue operations and proceed with planned significant new investments? Answer : After plugging in the appropriate numbers, I noticed that the break-even cash flow for OHC would be $6,600. That means that OHC would need to, at minimum , bring in this amount to continue operations. When plugging this number in, I noticed that $6,600 would be the minimum required amount to invest as well as continue operations. If I was on OHC’s board, we would need (at the very least) a $6,600 cash flow if we wanted to proceed with operations as well as the planned significant investments. 2. A hospital’s cost of capital is 10%. Its cash flow return on investment (ROI) based on replacement cost is 8%. Given this information, the hospital should not receive significant new investment. Answer True or False then explain your decision. Answer : True. The Cost of Capital is also known as the “hurdle rate.” This is the calculation or percentage that shows the minimum necessary return to accept or justify undertaking a capital project. In this case, the hospital’s cost of capital is 10%. That means that the hospital must at least have 10% return on investment for this to be a smart and valuable capital investment decision. If the ROI to implement a new investment decision is 8% then it is falling 2% under the minimum threshold and is not a valuable new investment decision. 3. Beverly Enterprises owns a nursing home that is currently earning $2 million in cash flow on an annual basis, but this amount is expected to drop in the future. The nursing home has a book value of $20 million, a replacement cost of $40 million, and a current sale value of $10 million. If Beverly Enterprises has a cost of capital equal to 15%, at what value of annual cash flow would Beverly Enterprises be likely to be sell or close the nursing home? Helpful hint:(fill out the spreadsheet for #3 by entering the current cash flow of $2,000,000 as well as the other information given. Then at the bottom of the sheet it will give you the answer that represents the cash flow at which you will be at the minimum cash required, the formula is set for one dollar less, at that point you would consider selling or closing the business. (answer is below the breakeven by $1) Answe r: After plugging in the appropriate numbers, it is noted that our break-even amount is $1,500,000 and therefore if we make $1,499,999 or less as annual cash flow, we will need to sell or close the nursing home.

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