Cedar Hill Hospital needs to expand its facilities and desires to obtain a new building on a piece of property adjacent to its present location. Two options are available to Cedar Hill, as follows:
Option 1: Buy the property, erect the building, and install the fixtures at a total cost of $600,000. This cost would be paid off in five installments: an immediate payment of $200,000, and a payment of $100,000 at the end of each of the next four years. The annual cash operating costs associated with the new facilities are estimated to be $12,000 per year. The new facilities would be occupied for thirteen years, and would have a total resale value of $300,000 at the end of the 13-year period.
Option 2: A leasing company would buy the property and construct the new facilities for Cedar Hill which would then be leased back to Cedar Hill at an annual lease cost of $70,000. The lease period would run for 13 years, with each payment being due at the BEGINNING of the year. Additionally, the company would require an immediate $10,000 security deposit, which would be returned to Cedar Hill at the end of the 13-year period. Finally, Cedar Hill would have to pay the annual maintenance cost of the facilities, which is estimated to be $4,000 per year. There would be no resale value at the end of the 13-year period under this option.
The hospital uses a discount rate of 14% and the total-cost approach to net present value analysis in evaluating its investment decisions.
1. Under option 1, the present value of all cash outflows associated with buying the property, erecting the building, and installing the fixtures is closest to:
A) $(200,000)
B) $(491,400)
C) $(600,000)
D) $(387,200)
2. Under option 1, the net present value of all cash flows is closest to:
A) $(456,000)
B) $(600,000)
C) $(300,000)
D) $(507,000)
3. Under option 2, the present value of all the annual lease payments of $70,000 is closest to:
A) $(466,200)
B) $(408,900)
C) $(483,700)
D) $(910,000)
4. Under option 2, the present value of all cash flows associated with maintenance costs is closest to:
A) $(23,400)
B) $(52,000)
C) $(70,100)
D) $(4,000)