Question

A hospital bought a new medical laser machine for 2,812,500 $. The machine will generate a cash flow of 562,500 $ for six years, which is the expected useful life starting Year 1. The cost of capital is 8 percent. The expected salvage value for each year is shown below:

Year	Salvage Value
0	2,812,500
1	2,250,000
2	1,687,500
3	937,500
4	375,000
5	93,750
6	0

Using NPV, determine at what year the hospital should dispose of the equipment.

Please make certain that you show your calculations.

Answer 1

		Present Value, if Salvage Value taken for year
Year	PVF@8%	year-0		Year-1		year-2		year-3		year-4		year-5		year-5
		Amount	PV	Amount	PV	Amount	PV	Amount	PV	Amount	PV	Amount	PV	Amount	PV
0	1	0		-$2,812,500	-$2,812,500	-$2,812,500	-$2,812,500	-$2,812,500	-$2,812,500	-$2,812,500	-$2,812,500	-$2,812,500	-$2,812,500	-$2,812,500	-$2,812,500
1	0.925926			$2,812,500	$2,604,167	$562,500	$520,833	$562,500	$520,833	$562,500	$520,833	$562,500	$520,833	$562,500	$520,833
2	0.857339					$2,250,000	$1,929,012	$562,500	$482,253	$562,500	$482,253	$562,500	$482,253	$562,500	$482,253
3	0.793832							$1,500,000	$1,190,748	$562,500	$446,531	$562,500	$446,531	$562,500	$446,531
4	0.73503									$937,500	$689,090	$562,500	$413,454	$562,500	$413,454
5	0.680583											$656,250	$446,633	$562,500	$382,828
6	0.63017													$562,500	$354,470
NPV				$0	-$208,333	$0	-$362,654	-$187,500	-$618,665	-$187,500	-$673,792	$93,750	-$502,796	$562,500	-$212,130
* End year = Residual Value + Cashflow generated for such year

In all the option NPV is Negative , hence it's recommended to sold the equipment at year 0 , to recover the salvage value equivalent to cost of Equipment.