You are considering the acquisition of a new piece of equipment with a useful li

Question

You are considering the acquisition of a new piece of equipment with a useful life of five years. This new technology will make your clinical operation more efficient and allow for a reduction of 10 FTEs. The equipment purchase price is $4,500,000 plus 10% installation fee. The purchase price includes service for the first year, an item that has an annual cost of $10,000. There is a potential for additional volume of 150,000 units in the first year, growing by 30,000 each year thereafter. The price charged per unit is $15.00 with a 50% collection rate. The staff being eliminated are paid $12.50 per hour. The fringe benefits rate is 20%. The hurdle rate is 7.5%. Question: What is the benefit/cost ratio, the average payback period, and the return on investment associated with this opportunity? Based on this information, would you pursue this opportunity? Explain your decision.

Explanation / Answer

a) Purchase Machine Year 0 1 2 3 4 Capital Expenditure $                                            (4,950,000.00) Revenue increases $                            1,125,000 $                          1,350,000 $                          1,575,000 $                              1,800,000 Expenses decreases $                                312,000 $                              312,000 $                              312,000 $                                 312,000 Expenses Increases $                              (10,000) $                              (10,000) $                                 (10,000) Total Benefit $                            1,437,000 $                          1,652,000 $                          1,877,000 $                              2,102,000 P.V Factor@7.5% 1 0.930 0.865 0.805 0.749 P.V $                                            (4,950,000.00) $                      1,336,410.00 $                    1,428,980.00 $                    1,510,985.00 $                        1,574,398.00 NPV= $                                               2,522,692.00 Working Capital Expenditure Equipment Purchase Price $                                               4,500,000.00 Installation ($450000*10%) $                                                  450,000.00 Total Captital Expenditure $                                               4,950,000.00 Year Year 1 Year 2 Year 3 Year 4 Year 5 Revenue Increases= 150000*15*50% (150000+30000)*15*50% (180000+30000)*15*50% (210000+30000)*15*50% (240000+30000)*15*50% Expenses decrease FTEs=(Full time Equivalent)=(Full time employees performs the work) 10 Emplyees*40 number of weeks per period*52 Weeks) Hours 10*40*52 Hours 20800 Expenses decrease 20800*12.5+(20800*12.5*20%) $                                                  312,000.00 Benefit Cost Ratio Benefit Year1 $                                                     1,437,000 Year2 $                                                     1,652,000 Year3 $                                                     1,877,000 Year4 $                                                     2,102,000 Year5 $                                                     2,327,000 $                                                     9,395,000 Cost $                                               4,950,000.00 Benefit Cost Ratio=(Benefit/Cost) ($9395000/4950000) 1.898 Total cash inflow $                                                     9,395,000 Average cash inflow=($9395000/5) $                                                     1,879,000 Average Payback period=( Cash outflow/Average Cash outflow) ($4950000/$1879000) 2.63 Return on investment= (Average annual return/Average Investment) Average benefits= $                                               1,879,000.00 Average Investment=($4950000/5) $                                               2,475,000.00 ROI=($1879000/$2475000)*100 75.92 % Yes ths opportunity should be accepted because NPV is positive & ROI is 75.92%

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