Question

For your analysis assume that the ASC uses a 9% discount rate for projects of this risk level, and that they will use a five-year time horizon. This is a taxexempt not-for-profit organization so there will not be any income tax effects to consider in the calculation.

After buying the equipment the center is expected to generate gross revenues of $95,000 each year in the first two years and it is expected to increase to $125,000 each year in the next three years. The services will be paid for by third parties and there is a demand for this new service. Deductions from revenue are expected to average 25% of gross revenues in each of the five years. The initial equipment cost is $180,000 and will cost $30,500 to install. After five years the equipment will be retired, and it is expected that it could be sold for $27,000.   

The costs for the service include part-time staffing costs of $11,000 and supply costs of $8,500 in each of the first two years. For the last three years, salaries are expected to be $15,000 and supplies are estimated to be $11,500 in each of those last three years. The equipment is under warranty in the first year so there is no extra fee paid. A maintenance contract costing $8,500 per year will be paid in years 2 through 5.   

Required: 1. Set up the spreadsheet by inputting the above assumptions in the appropriate cells.

2. Summarize your answer in the following table and note whether this is an attractive project from a purely financial point of view.   

Summarize your answer in the following table:

Description Your Answer

Net Present Value of Cash Flows:

Internal Rate of Return:

Is this an attractive project from a purely financial point of view based upon the numbers that you calculated above? Why did you make that decision?

Answer 1

I. Calculation of Net present value:

Particulars	Year 0	Year 1 ($)	Year 2 ($)	Year 3 ($)	Year 4 ($)	Year 5 ($)
Initial investment	180000+30500 = 210,500
Revenue		95,000	95,000	125,000	125,000	125,000
Deductions @25%		23,750	23,750	31,250	31,250	31,250
Salaries		11,000	11,000	15,000	15,000	15,000
Supply cost		8,500	8,500	11,500	11,500	11,500
Maitenance cost			8,500	8,500	8,500	8,500
Net cash flow(*)		51,750	43,250	58,750	58,750	58,750
Terminal Value						27,000
Discount factor @9%		0.9174	0.8417	0.7722	0.7084	0.6499
Discounted cash flows		47,475.45	36,403.525	45,366.75	41,618.5	55,728.925

* Since we are using net cash flows for the purpose of npv we did not consider Depreciation, since it is a non-cash expenditure.

Initial Investment = $ 210,500

Less: Cash Fllows    = $ 226,593.15‬

Net present value = $ 16,593.15

II. Calculation of IRR:

IRR = Lower Rate+ NPV at lower rate / NPV at lower rate - NVP at Higher rate * (Higher rate - lower rate)

From the below table IRR = 9% + 16,593.15/ 16,593.15 - (2016.15) * (12% - 9%)

= 9% + 0.8917 * 3%

let us assume that irr will lies between 9% to 12%

Net cash flow(*)		51,750	43,250	58,750	58,750	58,750
Terminal Value						27,000
Discount factor @9%		0.9174	0.8417	0.7722	0.7084	0.6499
Discounted cash flows		47,475.45	36,403.525	45,366.75	41,618.5	55,728.925
Discount factor @12%		0.8928	0.7972	0.7117	0.6355	0.5674
Discounted cash flows		46,202.4	34478.9	41812.375	37335.625	48,654.55
NPV @9%	16,593.15
NPV @10%	-2016.15