Chapter 10 Assignment page 317 problem10.2 California Imaging Center, a not-for-
ID: 2777698 • Letter: C
Question
Chapter 10 Assignment page 317 problem10.2
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?
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
Explanation / Answer
a.Estimate the projects net cash flows over its five-year estimated life. (hint: use the following format as a guide Ans) Year 0 1 2 3 4 5 Equipment Cost $ - Net Revenue $ (600,000) $ 300,000 $ 315,000 $ 330,750 $ 347,288 $ 364,652 Less:- Labour and Maintenance $ 100,000 $ 105,000 $ 110,250 $ 115,763 $ 121,551 Utilities Cost $ 10,000 $ 10,500 $ 11,025 $ 11,576 $ 12,155 Overheads $ 5,000 $ 5,250 $ 5,513 $ 5,788 $ 6,078 Operating income $ (600,000) $ 185,000 $ 194,250 $ 203,963 $ 214,161 $ 224,869 Equipment Salvage value 200000 Net Cash flow $ (600,000) $ 185,000 $ 194,250 $ 203,963 $ 214,161 $ 424,869 b. What are the project’s NPV and IRR? (Assume for now that the project has average risk.) Ans) NPV of the firm is Present value factor at 10% Present Value Present value factor at 20% Present Value Year 0 $ (600,000) 1 $ (600,000) $ 1 $ (600,000) Year 1 $ 185,000 0.909 $ 168,182 0.769 $ 142,308 Year 2 $ 194,250 0.826 $ 160,537 0.592 $ 114,941 Year 3 $ 203,963 0.751 $ 153,240 0.455 $ 92,837 Year 4 $ 214,161 0.683 $ 146,275 0.350 $ 74,984 Year 5 $ 424,869 0.621 $ 263,810 0.269 $ 114,429 NPV $ 622,242 $ 292,044 $ (60,502) NPV = $ 292,044 Total Change = 292044+60502 IRR = 292044/352546*20 16.57 IRR = 10+16.57 = 26.57% 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? Ans) If the project has hight risk then cost of capital will increase by 3 points NPV of the firm is Present value factor at 13% Present Value Present value factor at 20% Present Value Year 0 $ (600,000) 1 $ (600,000) $ 1 $ (600,000) Year 1 $ 185,000 0.885 $ 163,717 0.769 $ 142,308 Year 2 $ 194,250 0.783 $ 152,126 0.592 $ 114,941 Year 3 $ 203,963 0.693 $ 141,356 0.455 $ 92,837 Year 4 $ 214,161 0.613 $ 131,349 0.350 $ 74,984 Year 5 $ 424,869 0.543 $ 230,602 0.269 $ 114,429 NPV $ 622,242 $ 219,150 $ (60,502) NPV is = $ 219,150 Total Change is $ 279,652 IRR is = 219150/279652*17 13.32209317 New IRR is 13+13.3221 26.32%
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