With the minimum NPV calculations done, you now have a sense of how much the projects’ future earnings are worth in today’s money. There’s more work to do here though. Now we need to determine a possible range of cost of capital for the projects.
What You Know
3% is the minimum cost of capital, in other words no project can have a cost of capital lower than 3%. But what’s the highest cost of capital percentage the Board could assign to the project that would still allow Woodland Ridge Hospital to make a profit? That’s what you need to figure out. You have the minimum – 3%. Now you need to determine the maximum percentage for each project.
Your Job
Here’s what you need to do:
Figure out the cost of capital range for each project –One approach to figuring out a range is to start your NPV calculations at the lowest costs of capital. Then keep increasing the cost of capital percentage and re-calculating NPV until you get an NPV that shows a loss for the project; that’ll tell you how high the cost of capital can be for the hospital to not lose money on that project.
Find a way to present your results visually. You’ll want to show the client the relationship between the options at different costs of capital. I think a graph works particularly well, but you can come up with any method of displaying this information you think is effective.
Write a summary of the work for the Board. Explain the information they are seeing in your more visual presentation. Explain how the options compare to one another and the relationship between profitability and cost of capital.
When you are finished, I’ll submit your work to the Board, so they can make a decision on cost of capital for each project. Once you have that, you ’ll be able to complete your analysis.
