California Health Center, a for �profit hospital, is evaluating the purchase of new diagnostic equipment. The equipment, which costs $600,000, has an expected life of 5 years and an estimated pretax salvage value of $200,000at 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 15X250X80=$300,000.
Labor maintenance costs are expected to be $100,000 during the first year of operation, while utilities will cost another $10,000and cash overhead will increase by $5,000 in Year 1. The cost for expendable supplies is expected to average $5 per procedure during the first year. All costs and revenues, except depreciation, are expected to increase at 5% inflation rate after the first year.
The equipment falls into the MACRS five-year class for tax depreciation and hence is subject to following deprecation allowance;
Year Allowance
1 0.20
2 0.32
3 0.19
4 0.12
5 0.11
6 0.06
1.00
The hospital�s tax rate is 40%, and its corporate cost of capital is 10%
QUESTION
Estimate the project�s net cash flows over its five-year estimated life. (Hint: Use the following format as a guide.)
Year
0 1 2 3 4 5
Equipment cost
Net revenues
Less: Labor/maintenance costs
Utilities costs
Supplies
Incremental overhead
Operating income
Equipment salvage value __________________________________
Net cash flow __________________________________
2. What are the project�s NPV and IRR? (Assume for now that the project has average risk.)
3. Assume the project is assessed to have high risk and California Imaging Center adds or subtracts 3 percentage points to adjust for project risk. Now, what is the project�s NPV? Does the risk assessment change how the project�s IRR is interpreted?