California Health Center, a for-profit hospital, is evaluating the purchase of n
ID: 2656659 • Letter: C
Question
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 $200,000 at that time. The equipment is expected to be use 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 ned of bad debt losses and contractual allowances, in its first year of use. Thus, net revenues for year 1 are estimates at 15*250*$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 in year 1. the cost of expandable supplies is expected to average $5 per procedure during the first year. all costs and revenue, except depreciation, are expected to incresae at 5% inflation rate 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 depreciation cost of new equipment = $ 600,000.00 1 0.2 $ 120,000.00 life of new equipment = 5 years 2 0.32 $ 192,000.00 salvage value = $ 200,000.00 3 0.19 $ 114,000.00 Year 1 4 0.12 $ 72,000.00 annual revenue year 1= $ 300,000.00 5 0.11 $ 66,000.00 cost of salaries = $ 100,000.00 6 0.06 $ 36,000.00 utilities = $ 10,000.00 1 cash overhead = $ 5,000.00 cost of expandable suppies = $ 5.00 per procedure $ 18,750.00 per year tax = 40% WACC 10% cost of capital cost and revenue increase each year at rate of inflation= 5% the hospital's tax rate is 40%, and its corporate cost of capital is 10% A estimate the projects net cash flows over its 5-year estimated life (hint: use the following format as a guide) Year 0 1 2 3 4 5 equipment cost $ (600,000.00) net revenues $ 300,000.00 $ 315,000.00 $ 330,750.00 $ 347,287.50 $ 364,651.88 less: labor/maintenance costs $ (100,000.00) $ (105,000.00) $ (110,250.00) $ (115,762.50) $ (121,550.63) utilities costs $ (10,000.00) $ (10,500.00) $ (11,025.00) $ (11,576.25) $ (12,155.06) supplies $ (18,750.00) $ (19,687.50) $ (20,671.88) $ (21,705.47) $ (22,790.74) incremental overhead $ (5,000.00) $ (5,250.00) $ (5,512.50) $ (5,788.13) $ (6,077.53) depreciation $ (120,000.00) $ (192,000.00) $ (114,000.00) $ (72,000.00) $ (66,000.00) operating income $ 46,250.00 $ (17,437.50) $ 69,290.63 $ 120,455.16 $ 136,077.91 taxes 40% 40% 40% 40% 40% net operating income $ (600,000.00) $ 27,750.00 $ (10,462.50) $ 41,574.38 $ 72,273.09 $ 81,646.75 plus: depreciaiton $ 120,000.00 $ 192,000.00 $ 114,000.00 $ 72,000.00 $ 66,000.00 Plus: equipment salve value $ 134,400.00 net cash flow $ 147,750.00 $ 181,537.50 $ 155,574.38 $ 144,273.09 $ 282,046.75 B what are the projects's NPV and IRR (assume for now that the project has average risk 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 $200,000 at that time. The equipment is expected to be use 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 ned of bad debt losses and contractual allowances, in its first year of use. Thus, net revenues for year 1 are estimates at 15*250*$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 in year 1. the cost of expandable supplies is expected to average $5 per procedure during the first year. all costs and revenue, except depreciation, are expected to incresae at 5% inflation rate 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 depreciation cost of new equipment = $ 600,000.00 1 0.2 $ 120,000.00 life of new equipment = 5 years 2 0.32 $ 192,000.00 salvage value = $ 200,000.00 3 0.19 $ 114,000.00 Year 1 4 0.12 $ 72,000.00 annual revenue year 1= $ 300,000.00 5 0.11 $ 66,000.00 cost of salaries = $ 100,000.00 6 0.06 $ 36,000.00 utilities = $ 10,000.00 1 cash overhead = $ 5,000.00 cost of expandable suppies = $ 5.00 per procedure $ 18,750.00 per year tax = 40% WACC 10% cost of capital cost and revenue increase each year at rate of inflation= 5% the hospital's tax rate is 40%, and its corporate cost of capital is 10% A estimate the projects net cash flows over its 5-year estimated life (hint: use the following format as a guide) Year 0 1 2 3 4 5 equipment cost $ (600,000.00) net revenues $ 300,000.00 $ 315,000.00 $ 330,750.00 $ 347,287.50 $ 364,651.88 less: labor/maintenance costs $ (100,000.00) $ (105,000.00) $ (110,250.00) $ (115,762.50) $ (121,550.63) utilities costs $ (10,000.00) $ (10,500.00) $ (11,025.00) $ (11,576.25) $ (12,155.06) supplies $ (18,750.00) $ (19,687.50) $ (20,671.88) $ (21,705.47) $ (22,790.74) incremental overhead $ (5,000.00) $ (5,250.00) $ (5,512.50) $ (5,788.13) $ (6,077.53) depreciation $ (120,000.00) $ (192,000.00) $ (114,000.00) $ (72,000.00) $ (66,000.00) operating income $ 46,250.00 $ (17,437.50) $ 69,290.63 $ 120,455.16 $ 136,077.91 taxes 40% 40% 40% 40% 40% net operating income $ (600,000.00) $ 27,750.00 $ (10,462.50) $ 41,574.38 $ 72,273.09 $ 81,646.75 plus: depreciaiton $ 120,000.00 $ 192,000.00 $ 114,000.00 $ 72,000.00 $ 66,000.00 Plus: equipment salve value $ 134,400.00 net cash flow $ 147,750.00 $ 181,537.50 $ 155,574.38 $ 144,273.09 $ 282,046.75 B what are the projects's NPV and IRR (assume for now that the project has average riskExplanation / Answer
b. What are the project's NPV and IRR? (Assume that the project has average risk.) Year 0 1 2 3 4 5 MACRS 20.00% 32.00% 19.20% 11.52% 11.52% Equipment cost -$600,000 Net revenues $300,000 $315,000 $330,750 $347,287.5 $364,651.88 Less: Labor/maintenance costs -$100,000 -$105,000 -$110,250 -$115,762.5 -$121,550.63 Utilities costs -$10,000 -$10,500 -$11,025 -$11,576.25 -$12,155.06 Supplies -18750 -$19,687.5 -$20,671.88 -$21,705.47 -$22,790.74 Incremental overhead -$5,000 -$5,250 -$5,512.5 -$5,788.13 -$6,077.53 Depreciation -$120,000 -$192,000 -$115,200 -$69,120 -$69,120 Operating income -$600,000 $46,250 -$17,437.5 $68,090.63 $123,335.16 $132,957.91 Less Tax -$18,500 $6,975 -$27,236.25 -$49,334.06 -$53,183.17 Net operating Income $27,750 -$10,462.5 $40,854.38 $74,001.09 $79,774.75 Plus: Depreciation $120,000 $192,000 $115,200 $69,120 $69,120 Plus: After-tax equipment salvage value $120,000 Net cash flow -$600,000 $147,750 $181,537.5 $156,054.38 $143,121.09 $268,894.75 Cost of capital 10% 1 0.909090909 0.826446281 0.751314801 0.683013455 0.620921323 Present Value -$600,000 $134,318.18 $150,030.99 $117,245.96 $97,753.63 $166,962.48 NPV $66,311.25 IRR 13.94%
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