Reference no: EM133005103

Question - A hospital is planning to build a new building.

The project will cost £100 million and would generate FCF of £10 a year for the 15-year life of the building, after which it will be demolished at a zero net cost.

The hospital does not pay tax.

The land used for the new building has no alternative use.

The cost of capital for the FCFs is 10%.

a. What is the NPV of the project?

b. What is the IRR of the project's FCFs?

c. What is the IRR rule and can it be used reliably, in this case, to decide whether or not to go ahead with the project?

The hospital is considering borrowing debt for this project since it may be more profitable.

d. Construct a spreadsheet in which the hospital borrows £80 million at an interest rate of 5%.

Interest is paid annually and the loan is repaid in 15 years' time.

Work out the "total project cash flows" by adding the loan cash flows to the FCFs from the project and report that these total project cash flows have an IRR that is much higher than the project's cost of capital of 10%.

Show that it is correct in saying that the "total project cash flows" have an IRR that is higher than 10%.

What is the IRR?

e. Is the existence of an IRR greater than 10% for "total project cash flows" consistent with the project's NPV that you have calculated in part (a)? Explain your answer.

f. Should the hospital go ahead with the project?