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Purchase evaluation for a healthcare organization considering purchasing a building costing $3,000,000 with a resale value of $4,000,000 in 5 years. The evaluation includes calculating the present value of the purchase, considering potential rental income, comparing investment options with Certificates of Deposit at different banks, and assessing the financial attractiveness of each scenario. The analysis incorporates the time value of money, interest rates, and strategic considerations. The study aims to provide a comprehensive recommendation on whether to proceed with the purchase and rental plans based on financial viability and other relevant issues.

Paper For Above instruction

Introduction

Financial decision-making within healthcare organizations necessitates a thorough analysis of potential investments, considering both immediate costs and long-term benefits. When contemplating purchasing a property such as a building, organizations must evaluate not only the purchase price and resale value but also the opportunity costs associated with alternative investments, such as certificates of deposit (CDs). This paper investigates the financial implications of acquiring a $3 million property, including the potential rental income, and compares this to remaining in the current facility while investing the equivalent amount in CDs offered by two banks with different compounding frequencies. The goal is to determine the most advantageous financial strategy based on present and future values, considering the organization’s risk tolerance and strategic goals.

Evaluation of Building Purchase and Rental Income

The initial step involves calculating the present value (PV) of the building purchase, considering the future resale value of $4 million after 5 years. With an annual discount rate of 8%, this calculation helps ascertain whether the investment’s future cash flows justify the initial expenditure. Using the present value formula:

PV = Future Value / (1 + r)^n

where the future value is $4 million, r is 8%, and n is 5 years, the PV of the resale value is approximately:

PV = $4,000,000 / (1 + 0.08)^5 ≈ $4,000,000 / 1.4693 ≈ $2,723,073

This analysis indicates that, at an 8% discount rate, the present worth of the future resale value is approximately $2.72 million, which is less than the current purchase price of $3 million. Hence, solely based on resale value, the investment appears less favorable unless rental income or other benefits are considered.

However, if the organization can earn $300,000 annually in rent, the next step is to compute the present value of this rental income stream over five years. Assuming rent is paid at the end of each year, the present value of an ordinary annuity is calculated using:

PV of Annuity = P × [(1 - (1 + r)^-n) / r]

where P is $300,000, r is 8%, and n is 5 years. Plugging in these values:

PV = $300,000 × [(1 - (1 + 0.08)^-5) / 0.08] ≈ $300,000 × 3.993 ≈ $1,198,000

Adding the present value of the future resale to the rental income’s PV yields total potential benefits:

Total PV = $1,198,000 + $2,723,073 ≈ $3,921,073

This suggests that leasing part of the building and investing in the property could potentially outweigh the initial purchase cost, making the investment more attractive.

Comparison with CD Investment Options

Alternatively, the organization can invest the $3 million in CDs with different compounding interest rates: 4.2% compounded semiannually at First National Bank and 4% compounded monthly at Second National Bank. To compare these, the effective annual rates (EAR) for each bank are computed:

- First National Bank:

EAR = (1 + (0.042 / 2))^2 - 1 = (1 + 0.021)^2 - 1 ≈ 1.021^2 - 1 ≈ 1.0424 - 1 = 0.0424 or 4.24%

- Second National Bank:

EAR = (1 + (0.04 / 12))^12 - 1 ≈ (1 + 0.00333)^12 - 1 ≈ 1.0424 - 1 ≈ 0.0424 or 4.24%

Both banks effectively offer approximately 4.24% annual return, but due to compounding differences, the actual future value (FV) after 5 years for both can be calculated using:

FV = PV × (1 + EAR)^n

where PV is $3 million:

FV = $3,000,000 × (1 + 0.0424)^5 ≈ $3,000,000 × 1.226 ≈ $3,678,000

This future value exceeds both the valuation based on resale and rental income, implying that investing in CDs could be a more financially advantageous alternative over the five-year horizon, especially considering minimal property management costs and uncertainties.

The time value of money plays a critical role here, with higher discount rates reducing the present worth of future benefits and lower effective interest rates favoring investment in fixed-income securities. The choice between property purchase and CD investment hinges on risk considerations, liquidity needs, and strategic organizational priorities.

Additional Considerations and Conclusions

Beyond quantitative analysis, several qualitative factors influence the decision. These include the potential for property appreciation beyond the projected resale value, tax implications of property ownership versus investment income, and the flexibility to acquire or dispose of assets. Management’s risk appetite and operational needs are also pivotal; owning property entails maintenance and operational costs, while investing in CDs offers liquidity and lower management effort.

In conclusion, based solely on financial calculations, investing in CDs with the current interest rates appears more advantageous than purchasing the property, especially if the organization does not anticipate significant appreciation or rental income. However, if the organization seeks to maintain control over the property or foresees strategic benefits, purchasing combined with rental income could still be appealing. Ultimately, a balanced approach considering both quantitative analysis and organizational strategy is essential before making a final decision.

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