Question

The Eastern College of Veterinary Medicine Veterinary Teaching Hospital (VTH), a nonprofit tax-exempt organization, is considering leasing a CT unit for their radiology service. The lease term will be $47,784 paid annually for six years. At the end of the lease, the hospital will own the unit.

The radiologists would like to charge $375 per scan, and they expect to do 330 scans in the first year and 430 scans in each subsequent year. A maintenance agreement costs $104,000 per year, but that does not cover replacement of the tube. On average, a tube will last ten years at the projected volume, and a tube replacement will cost $140,000.

1. In Excel, calculate the net present value (NPV) of the six-year lease term, using a discount rate of 5%.

2. What would the NPV be if the college were able to operate the CT for ten years (four more years, without lease payments)?

3. Calculate the IRR for the ten-year investment.

4. As the hospital director for the VTH, generate an executive summary that details why you would or would not recommend this investment. What are the risks?

Answer 1

VTH can consider the returns from the investment done in the following manner :-

1. If the project is considered for a 6 year period, then the equipment will start rendering positive returns from the 2nd year. NPV works out to $12,332/- (approximately),

2. If the project is considered for a 10 year period, then NPV works out to $81,963 (approximately) with IRR of 47%.

While making an investment in such projects, management has to consider the below mentioned points :-

1. Constant power supply and backup.

2. Increase in usage of equipment. In the above mentioned example, management is not considering scans beyond 36 per month. This may increase to beyond 2 scans per day. Thereby the project may render greater profitability.

3. Depreciation of asset is a factor that is being ignored.

Option 1 workings for calculating NPV for 6 year Lease period

Year	Lease Amt 1	Maintenance Exp 2	Scans 3	Rate of Scans 4	Income from Scans 5=(3*4)	Net Amount (5-(1+2))
1	47784	104000	330	375	123750	-28034
2	47784	104000	430	375	161250	9466
3	47784	104000	430	375	161250	9466
4	47784	104000	430	375	161250	9466
5	47784	104000	430	375	161250	9466
6	47784	104000	430	375	161250	9466
					NPV Value for 6 years	$12,332.22 (approximately)

Option 2 with 10 year NPV and IRR Calculations

10 year period

Year	Lease Payment (1)	Maintenance Exp (2)	Scans (3)	Rate of Scans (4)	Income From Scans 5= (3*4)	Net Amount (5-(1+2))
1	47784	104000	330	375	123750	-28034
2	47784	104000	430	375	161250	9466
3	47784	104000	430	375	161250	9466
4	47784	104000	430	375	161250	9466
5	47784	104000	430	375	161250	9466
6	47784	104000	430	375	161250	9466
7		104000	430	375	161250	57250
8		104000	430	375	161250	57250
9		104000	430	375	161250	57250
10		104000	430	375	161250	57250
	Replacement Cost					-140000

NPV Value for 10 years Project - $81,963.07/-

IRR Value for 10 years Project - 47%

Risks associated with the project is :-

1. Quality of the equipment supplied should be good,

2. Orders or scans is the source of income and need to be as per plan.

Considering the above mentioned risks, the project looks viable for a longer term of 10 years rather than for a 6 year period.