Question

Chicago Hospital, a taxpaying entity, estimates that it can save $28,000 a year in cash operating costs for the next 10 years if it buys a special-purpose eye-testing machine at a cost of $110,000. No terminal disposal value is expected. Chicago Hospital's required rate of return is 10%. Assume all cash flows occur at year-end except for initial investment amounts. Chicago Hospital uses straight-line depreciation. The income tax rate is 30% for all transactions that affect income taxes. Present Value of $1 table Present Value of Annuity of $1 table Future Value of $1 table Future Value of Annuity of $1 table Read the requirements.

Answer 1

Part 1

A. Net Present value = present value of cash inflows – present value of cash outflows

Cash inflow from operation before taxes	28000
Less: depreciation (110000/10)	11000
Income before taxes	17000
Taxes (30%)	5100
Net income	11900
Add: depreciation	11000
Cash flow from operations	22900

Present value of cash inflows = 22900*PVIFA(10%, 10) = 22900*6.14457 = 140710.65

NPV = 140710.65-110000 = $30710.65 (if answer is required to 0 decimal places, answer will be $30711)

B. Payback period = initial investment / Cash flow from operations = 110000/22900 = 4.80 years

C. IRR

IRR factor = 110000/22900 = 4.803 years

The PVIFA factor (16%, 10) = 4.833

The PVIFA factor (18%, 10) = 4.494

It means IRR is between 16% and 18%

Therefore,

(0.339)Y = (0.02*0.030)

Y = 0.00174

Therefore,

IRR= 16%+0.17% = 16.17%

D. accrual accounting rate of return based on net initial investment = net income / initial investment =11900/110000 = 10.82%

E. accrual accounting rate of return based on average investment = net income / initial investment =11900/((110000+0)/2) = 21.64%

Part 2

A	Net present value	Increase
B	Payback period	No change
C	Internal rate of return	Increase
D	accrual accounting rate of return based on net initial investment	No change
E	accrual accounting rate of return based on average investment	Decrease

Due to terminal disposal value, there the cash inflow of the last year will increase and thus it affects NPV and IRR. Moreover, due to change disposal value there will be average investment will increase