Question

10.2 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 cach year of the project's life. On average, cach procedure is projected to generate $80 in cash collections during the first year of use. Thus, net revenues for the year 1 are estimated at 15 x 20 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 in year 1. The cost for expandable supplies is expected to average $5 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 project's net cash flow over its five-year estimated life. (Hint: use the following format as a guide.) YEAR 1 2 Equipment cost Net revenues Less: Labor/maintenance costs Utilities costs Supplies Incremental overhead Operating Income Equipment salvage value Net cash flow b) What are the project's NPV and IRR? (Assume for now that the project has average risk)

Answer 1

NPV

		Year
		$                       -	1	2	3	4	5
	Equipment Cost	$      600,000.00	$                    -	$                    -	$                    -	$                    -	$                    -
	Net Reveues	$                       -	$ (300,000.00)	$ (315,000.00)	$ (330,750.00)	$ (347,287.50)	$ (364,651.88)
Less	Labour Cost	$                       -	$ 100,000.00	$ 105,000.00	$ 110,250.00	$ 115,762.50	$ 121,550.63
	Utilities Cost	$                       -	$     10,000.00	$     10,500.00	$     11,025.00	$     11,576.25	$     12,155.06
	Supplies	$                       -	$     18,750.00	$     19,687.50	$     20,671.88	$     21,705.47	$     22,790.74
	Incremental Overhead	$                       -	$       5,000.00	$       5,250.00	$       5,512.50	$       5,788.13	$       6,077.53
	Operating Income	$                       -	$ (166,250.00)	$ (174,562.50)	$ (183,290.63)	$ (192,455.16)	$ (202,077.91)
	Equipment Salvage Value	$                       -	$                    -	$                    -	$                    -	$                    -	$ (200,000.00)
	Net Cashflow		$ (166,250.00)	$ (174,562.50)	$ (183,290.63)	$ (192,455.16)	$ (402,077.91)
	PV Factor @10%		0.9091	0.8264	0.7513	0.6830	0.621
	Present Value		$ (151,136.36)	$ (144,266.53)	$ (137,708.96)	$ (131,449.46)	$ (249,658.75)
	Net Present Value	$    (214,220.06)

IRR

Cost of Equipment	$     600,000.00
Average Cash inflow	(183,727.24)
Factor	$                (3.27)
Factor is 16% for 5 years in annuty table

	Year
	$                                             -	1	2	3	4	5	NPV
Net Cashflow	$                           600,000.00	(166,250)	(174,563)	(183,291)	(192,455)	(402,078)
PV Factor @16%		0.8621	0.7432	0.6407	0.5523	0.476
	$                           600,000.00	(143,318.97)	(129,728.37)	(117,426.55)	(106,291.27)	(191,434.53)	$    (88,199.68)
PV Factor @18%		0.847	0.718	0.609	0.516	0.437
	$                           600,000.00	(140,889.83)	(125,368.07)	(111,556.33)	(99,266.23)	(175,751.96)	$    (52,832.42)
							$ (141,032.11)
IRR	16% + (NPV @ 18%/Total Difference )* Difference in Rate
IRR	17.25%