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. 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
|