Delta Star Incorporated
Content
Delta Star Incorporated
Delta Star Incorporated is a family owned convalescent-care facility. It has been in existence for 10 years and plan to maintain ownership for an additional 10 years, at which time they plan to sell all holdings in the industry.
Currently, Delta Star is considering two investment options to increase profitability. Profitability of the two projects will be determined by examining the net present value (NPV) and internal rate of return (IRR). The most profitable project over the next 10 years will be recommended to Delta Star Inc.
Project A The first investment option is the construction of a new twenty-six bed convalescent facility, to be build in a new area where the demand and price structure are basically similar to those currently being experienced by the company. Delta Star would operate the facility for 10 years and then liquidate.
The facility is expected to cost $468,000, based on a cost figure of $18,000 per bed plus 6% inflation. Plant operations and maintenance expense is expected to be slightly lower since the facility will be new, as a result the 6% inflation will not be added. A well-organized management will result in lower operation costs. Profits will not be hidden in wages and leases as they had been in prior years financial statements. All account charges will have a 3% expected inflation increase added. Straight-line depreciation will be used over a depreciable life of 31.5 years. Working
capital is expected to be 15% of incremental sales. Financing will be through federal bonds at 10% interest rate. The firm has a federal and state tax rate of 40%.
Project B The second investment option involves the construction of a new facility that specializes in maximum-care equipment, catering to patients requiring total respiration support and maintenance.
The facility is expected to cost $572.000 based on a cost figure of $20,000 per bed for a period of 10 years. A maximum-care facility is expected to bring in 20% higher rate per-bed. The projected patient-care inflows for the first year are set at 120% plus 3% inflation per-bed, and then 3% incremental increases from year 2 thru 9. Nursing cost will be calculated as 105% of the standard per-bed cost pus 3% for inflation. Similar to Project A; straight-line depreciation over 31.5 years will be used. Working capital is expected to be 15% of incremental sales. Financing will be done through federal bonds at 10% interest rate. The firm has a federal and state tax rate of 40%.
Determining Profitability Exhibit A and B were created with all the relevant information necessary to make an informal decision. Exhibit 7 and 8 provided useful information to reach our decision. We know the initial costs for both investment options (Project A= $468,000 & Project B= $572,000). We subtract the variable costs and depreciations from
revenues projected in exhibit 7 for each of the 10years to give us EBIT (earning before income tax). Income tax cost was based on the 40% estimated tax rate, which was deducted from EBIT to give us net income.
Now we added the depreciation cost back, a non-cash expense, to give us our annual cash flows, which was added with our NWC to ultimately give us net cash flow. Keeping in mind that Delta wanted to liquidate investment after 10years we included salvage value of the property (subtracted 10 years of straight line depreciation from the usefully life).
Project A NPV= $258,357.71 IRR= 19.26%
Project B NPV= $532,227.10 IRR= 25.40%
Recommendation We recommend that Delta Star Inc invest in Project B based on the net present value and internal rate of return. Even though the initial cost of project B is higher by $104,000 then project A, it would yield a higher net income and net cash flow for
next 10years. Additionally, Project B also yields a higher NPV and IRR over the next 10 years then project A.
Delta Star Incorporated is a family owned convalescent-care facility. It has been in existence for 10 years and plan to maintain ownership for an additional 10 years, at which time they plan to sell all holdings in the industry.
Currently, Delta Star is considering two investment options to increase profitability. Profitability of the two projects will be determined by examining the net present value (NPV) and internal rate of return (IRR). The most profitable project over the next 10 years will be recommended to Delta Star Inc.
Project A The first investment option is the construction of a new twenty-six bed convalescent facility, to be build in a new area where the demand and price structure are basically similar to those currently being experienced by the company. Delta Star would operate the facility for 10 years and then liquidate.
The facility is expected to cost $468,000, based on a cost figure of $18,000 per bed plus 6% inflation. Plant operations and maintenance expense is expected to be slightly lower since the facility will be new, as a result the 6% inflation will not be added. A well-organized management will result in lower operation costs. Profits will not be hidden in wages and leases as they had been in prior years financial statements. All account charges will have a 3% expected inflation increase added. Straight-line depreciation will be used over a depreciable life of 31.5 years. Working
capital is expected to be 15% of incremental sales. Financing will be through federal bonds at 10% interest rate. The firm has a federal and state tax rate of 40%.
Project B The second investment option involves the construction of a new facility that specializes in maximum-care equipment, catering to patients requiring total respiration support and maintenance.
The facility is expected to cost $572.000 based on a cost figure of $20,000 per bed for a period of 10 years. A maximum-care facility is expected to bring in 20% higher rate per-bed. The projected patient-care inflows for the first year are set at 120% plus 3% inflation per-bed, and then 3% incremental increases from year 2 thru 9. Nursing cost will be calculated as 105% of the standard per-bed cost pus 3% for inflation. Similar to Project A; straight-line depreciation over 31.5 years will be used. Working capital is expected to be 15% of incremental sales. Financing will be done through federal bonds at 10% interest rate. The firm has a federal and state tax rate of 40%.
Determining Profitability Exhibit A and B were created with all the relevant information necessary to make an informal decision. Exhibit 7 and 8 provided useful information to reach our decision. We know the initial costs for both investment options (Project A= $468,000 & Project B= $572,000). We subtract the variable costs and depreciations from
revenues projected in exhibit 7 for each of the 10years to give us EBIT (earning before income tax). Income tax cost was based on the 40% estimated tax rate, which was deducted from EBIT to give us net income.
Now we added the depreciation cost back, a non-cash expense, to give us our annual cash flows, which was added with our NWC to ultimately give us net cash flow. Keeping in mind that Delta wanted to liquidate investment after 10years we included salvage value of the property (subtracted 10 years of straight line depreciation from the usefully life).
Project A NPV= $258,357.71 IRR= 19.26%
Project B NPV= $532,227.10 IRR= 25.40%
Recommendation We recommend that Delta Star Inc invest in Project B based on the net present value and internal rate of return. Even though the initial cost of project B is higher by $104,000 then project A, it would yield a higher net income and net cash flow for
next 10years. Additionally, Project B also yields a higher NPV and IRR over the next 10 years then project A.
