California Imaging Center, a not-for-profit business, is evaluating the purchase

Question

California Imaging Center, a not-for-profit business, is evaluating the purchase of new diagnostic equipment, The equipment, which costs $600,000, has an expected life of five years and an estimated 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 cash collections during the 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 and cash overhead will increase by $5,000 per procedure during the first year. All costs and revenues are expected to increase at a 5 percent inflation rate after the first year. The center’s corporate cost of capital is 10 percent.
a.Estimate the projects 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 Revenue
Less :Labor/Maintenance costs
Utilities Costs
Supplies
Incremental overhead
Operating Income
Equipment Salvage Value
Net Cash Flow
I
b. What are the project’s NPV and IRR? (Assume for now that the project has average risk.)
c. Assume the project is assessed to have high risk and California Imaging Center adds or subtracts 3 percent 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?

Explanation / Answer

solution.

$347,288

calculation of NPV =

NPV = 512,957.43

Calculation of IRR

NPV @ 10%      = 512,957.43

                                    512,957.43 - 600,000 = - 87042.57

NPV @ 3%           = 628,018..31 ..

                               = 628,018..31- 600,000 = 28018.31

IRR   = 10% + 87042.57 / 115,060.88 x 7%

           = 15.29%

Year     0 1 2 3 4 5 Equipment Cost $600,000 $600,000 $600,000 $600,000 $600,000 $600,000 Net Revenue $300,000. $300,000. $315,000. $330,750. $364,652 Less :Labor/Maintenance costs $100,000 $100,000 $105,000 $110,250 $115,763 $121,551 Utilities Costs 0 $10,000 0 0 0 Supplies 0 0 0 0 0 ncremental overhead 0 5,000 0 0 0 0 Operating Income 0 185,000 210,000 220,500 231.529 243,101 Equipment Salvage Value 0 80,000 80,000 80,000 80,000 80,000 Net Cash Flow 0 105,000 130,000 140,500 151,529 163,101

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