Question

Georgia Health Center, a for profit hospital, is evaluating the purchase of a new diagnostic equipment. The equipment, which cost $600,000, has an expected life of five years and an estimated pretax salvage value of $200,000 at that time. The equipment is expected to be used 15 times a day for 250 days a year for each year of the project’s life. On average, each procedure is expected to generate $80 in collections, which is net of bad debt losses and contractual allowances, in its first year of use. Thus, net revenues for Year 1 are estimated at 15 x 250 x $80= $300,000

Labor and maintenance costs are expected to be $100,000 during the first year of operation, while utilities will cost another $10,000. The cost for expendable supplies is expected to average $5 per procedure during the first year. Cash overhead will increase by $5,000 in Year 1. All costs and revenues, except depreciation, are expected to increase at 5 percent inflation rate per year after the first year.

The equipment falls into the MACRS five-year class for tax depreciation and is subject to the following depreciation allowances:

Year	Allowance
1	0.20
2	0.32
3	0.19
4	0.12
5	0.11
6	0.06

The hospital’s tax rate is 40 percent, and its corporate cost of capital is 8%.

You can use Excel to complete this problem. If you do, please submit your homework document and the Excel file.

a. Estimate the project’s net cash flows over its five-year estimated life. Hint: complete the following table.

	0	1	2	3	4	5
Equipment cost
Net revenue
Less:
Labor & Maintenance
Utilities costs
Supplies
Incremental overhead
Depreciation
Income before taxes
Taxes (40%)
Project’s net income
Plus: Depreciation
Plus: Net salvage value

b. What’s the project’s NPV?

c. What’s the project’s IRR?

Answer 1

a) Estimated projects net cash flows over five year:
	0	1	2	3	4	5	NPV	present values for IRR
Equip cost	-600000
Net revenue		300000	315000	330750	347287.5	364651.9
Less:
labor & mainte.		100000	105000	110250	115763	121551
Utilities costs		10000	10500	11025	11576	12155
Supplies		18750	19688	20672	21705	22791
Incremental overhead		5000	5250	5513	5788	6078
Depreciation		80000	128000	76000	48000	44000
Income before taxes		86250	46563	107291	144455	158078
Taxes 0.40		34500	18625	42916	57782	63231
Project's net income		51750	27938	64374	86673	94847
Plus: Dep.		80000	128000	76000	48000	44000
Plus: Net Salvage value						120000
a) Net Cash Flow	-600000	131750	155938	140374	134673	258847
Discount 8%	1	0.926	0.857	0.794	0.735	0.681
NPV	-600000	122001	133638	111457	98985	176275	42356	642356
discount 9%		0.917	0.842	0.772	0.708	0.65
PV - 9%		120815	131299	108369	95349	168250		624082
b) NPV = $42356
c) IRR = 8% + (642356-600000)/(642356-624082)% = 8% + 2.32% = 10.32%