solution

Ridgewood Healthcare Enterprises is in possession of a non-operational 70-bed hospital. The after tax value of the land is $500,000. The equipment and the building are fully depreciated and have an after tax market value of $1,250,000. Ridgewood could either sell off its property or convert it into a fully functional nursing home for private-paying residents. An analysis of the market reveals that the facility could easily draw 100 patients per year, which is maximum capacity, at an initial reimbursement of $3,500 per resident per month for the first year, and increasing annually by $100 per month thereafter. Renovation costs to create a plush facility would be $20 million. The new facility would be depreciated on a straight-line basis over a ten-year life to a $2 million salvage value. At the end of ten years, the land is expected to be sold for an after tax value of $1.5 million. Net working capital will increase at a rate of $175,000 per year over the life of the project. Ridgewood has a 35 percent tax rate and has a required rate of return of 9 percent. The pro forma earnings before tax, which includes the deduction for depreciation expense, is projected to be $1,500,000 the first year and increase by $70,000 every year thereafter. Use the NPV technique and IRR method to evaluate this project. (Hint: see Appendices C, D and E.)