California Imaging Center, a not-for-profit business, is evaluating the purchase
ID: 2711045 • Letter: C
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.)
Insert your response here.
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?
Insert your response here.
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.)
Insert your response here.
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?
Insert your response here.
Explanation / Answer
Year 0 1 2 3 4 5 Equipment Cost -600000 Net Revenue 300000 315000 330750 347288 364652 Less :Labor/Maintenance costs 100000 105000 110250 115763 121551 Utilities Costs 10000 10500 11025 11576 12155 Supplies Incremental overhead 5000 5250 5513 5788 6078 Operating Income 185000 194250 203963 214161 224869 Equipment Salvage Value 200000 Net Cash Flow -600000 185000 194250 203963 214161 424869 Discount rate 1 0.909 0.826 0.751 0.683 0.621 Discounted cash flow -600000 168165 160450.5 153175.8 146271.7 263843.4 Total PV outflow -600000 Total PV inflow 891906.5 NPV=Present value inflow- Present value of outflow 891906-600000 291906 IRR Computation Net Cash Flow -600000 185000 194250 203963 214161 424869 Discount rate 1 0.800 0.640 0.512 0.410 0.328 Discounted cash flow -600000 148000 124320 104428.8 87805.86 139356.9 Total PV outflow -600000 Total PV inflow 603911.6 NPV 3911.576 NPV is close to Zero when the discount rate is 25% hence the IRR is 25%
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