Question

Calexico Hospital plans to invest in a new MRI machine. The cost of the MRI is $1.8 million. The MRI has an economic life of 5 years, and it will be depreciated over a five-year life to a $400,000 salvage value. Additional revenues attributed to the new MRI will be in the amount of $1.5 million per year for 5 years. Additional operating expenses, excluding depreciation expense, will amount to $1 million per year for 5 years. Over the life of the machine, net working capital will increase by $30,000 per year for 5 years.

A. Assuming that the hospital is a non-profit entity, what is the project’s net present value (NPV) at a discount rate of 8%, and what is the project’s IRR?

b. Assuming that the hospital is a for-profit entity and the tax rate is 30%, what is the project’s NPV at a cost of capital of 8%, and what is the project’s IRR?

Answer 1

Non-tax entity
Year	0	1	2	3	4	5
Revenues		1500000	1500000	1500000	1500000	1500000
Expenses		1000000	1000000	1000000	1000000	1000000
Less: initial investment	1800000
Add:salvage						400000
Less: working capital	30000
Recovery of working capital						30000
Overall cash flow	-1830000	500000	500000	500000	500000	930000
NPV @ 8%	459005.79
IRR	16.25%
Taxable entity
Year	0	1	2	3	4	5
Revenues		1500000	1500000	1500000	1500000	1500000
Expenses		1000000	1000000	1000000	1000000	1000000
Depreciation		280000	280000	280000	280000	280000
EBT		220000	220000	220000	220000	220000
Tax @ 30%		66000	66000	66000	66000	66000
PAT		154000	154000	154000	154000	154000
Add: depreciation		280000	280000	280000	280000	280000
Less: initial investment	1800000
Add:salvage						400000
Less: working capital	30000
Recovery of working capital						30000
Overall cash flow	-1830000	434000	434000	434000	434000	864000
NPV @ 8%	195486.93
IRR	11.57%