14.7 California Health Center, a for-profit hospital,is evaluating the purchase of new diagnostic equipment. Theequipment, which costs $600,000, has an expected life of five yearsand an estimated pretax salvage value of $200,000 at that time. Theequipment is expected to be used 15 times a day for 250 days a yearfor each year of the project’s life. On average, each procedure isexpected to generate $80 in collections, which is net of bad debtlosses and contractual allowances, in its first year of use. Thus,net revenues for Year 1 are estimated at 15 × 250 × $80 =$300,000.
Labor and maintenance costs are expected to be$100,000 during the first year of operation, while utilities willcost another $10,000 and cash overhead will increase by $5,000 inYear 1. The cost for expendable supplies is expected to average $5per proce- dure during the first year. All costs and revenues,except deprecia- tion, are expected to increase at a 5 percentinflation rate after the first year.
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e equipment falls into the MACRS five-year class fortax depreciation and is subject to the following depreciationallowances:
Year Allowance
1 0.20 2 0.323 0.19 4 0.125 0.11 6 0.06
1.00
The hospital’s tax rate is 40 percent, and itscorporate cost of capi- tal is 10 percent.
a. Estimate the project’s net cash flows over itsfive-year estimated life. (Hint: Use the following format as aguide.)
Year
012345
Equipment cost Net revenues Less: Labor/maintenancecosts
Utilities costs Supplies Incremental overheadDepreciation
Operating income Taxes
Net operating income Plus: Depreciation Plus:Equipment salvage value
Net cash flow
b. What are the project’s NPV and IRR? (Assume for nowthat the project has average risk.)
