Question

Problem 9 (10 points Aswer the following questions using the information below Jonesville Hospital has been considering the purchase of a new x-ray machine. The existing achi iN operable for five more years and will have a zero disposal price. If the machine is sdisposed now, it may be sold for $90,000. The new machine will cost $650,000 and an will reduee he average amount of time required to take the x-rays and will allow an additional cash investment in working capital of $20,000 will be required. The new machine additional r business to be done at the hospital, The investment is expected to net S60,000 in additional cash inflows during the year of acquisition and $230,000 each additional of use. The new machine has a five-year life, and zero disposal value. These cash tlows wvill generally occur throughout the year and are recognized at the end of each year. Income taxes are not considered in this problem. The working capital investment will not be recovered at the end of the asset's life. 1) What is the net present value of the investment, as 12% Would the hospital want to purchase the nessuming the required rate of return is machine? 2) What is the net present value of the investment, assuming the required rate of return is 20%? Would the hospital want to purchase the new machine? 3) In using the net present value method, only projects with a zero or positive net present value are acceptable because: Problem 9 (10 points) Answer the following questions using the information below: Jonesville Hospital has been considering the purchase of a new x-ray machine. The existing machine is operable for five more years and will have a zero disposal price. If the machine is disposed now, it may be sold for $90,000. The new machine will cost $650,000 and an additional cash investment in working capital of $20,000 will be required. The new machine will reduce the average amount of time required to take the x-rays and will allow an additional amount of business to be done at the hospital. The investment is expected to net 360,000 in additional cash inflows during the year of acquisition and $230,000 each additional year of use. The new machine has a five-year life, and zero disposal value. These cash flows will generally occur throughout the year and are recognized at the end of each year. Income taxes are not considered in this problem. The working capital investment will not be recovered at the end of the asset's life. 1) What is the net present value of the investment, assuming the required rate of return 1S 12%? Would the hospital want to purchase the new machine? 2) What is the net present value of the investment, assuming the required rate of return is 20%? Would the hospital want to purchase the new machine? 3) In using the net present value method, only projects with a zero or positive net present value are acceptable because:

Answer 1

Solution:

	$
Cost of the New Machine	6,50,000.00
Additional Investment in Working Capital	20,000.00
	6,70,000.00
Less: Scrap Value of Old Machine	90,000.00
Net Initial Investment	5,80,000.00

Solution 1) Calculation of Net Present Value of the Investment if the required rate of return is 12%

Year	Incremental Cash Inflows $	Present Value Factor @ 12%	Present Value of Incremental Cash Inflows $
1	60,000.00	0.892857	53,571.43
2	2,30,000.00	0.797194	1,83,354.59
3	2,30,000.00	0.711780	1,63,709.46
4	2,30,000.00	0.635518	1,46,169.16
5	2,50,000.00	0.567427	1,41,856.71
		Total Present Value of Incremental Cash Inflows $	6,88,661.35

Note: The last year’s cash inflows also include recovery of additional working capital of $20,000

Net Present Value = Total Present Value of Incremental Cash Inflows $ - Net Initial Investment

                                     = $6,88,661.35 - $5,80,000.00

                               = $108,661.35

As the Net Present Value at the required rate of return of 12% is positive, the company should purchase the new machine.

Solution 2) Calculation of Net Present Value of the Investment if the required rate of return is 20%

Year	Incremental Cash Inflows $	Present Value Factor @ 20%	Present Value of Incremental Cash Inflows $
1	60,000.00	0.833333	50,000.00
2	2,30,000.00	0.694444	1,59,722.22
3	2,30,000.00	0.578704	1,33,101.85
4	2,30,000.00	0.482253	1,10,918.21
5	2,50,000.00	0.401878	1,00,469.39
		Total Present Value of Incremental Cash Inflows $	5,54,211.68

Net Present Value = Total Present Value of Incremental Cash Inflows $ - Net Initial Investment

                                     = $5,54,211.68 - $5,80,000.00

= -$25,788.32

As the Net Present Value at the required rate of return of 20% is negative, the company should not purchase the new machine.

Solution 3) In using the Net Present Value Method. Only the projects with zero or positive net present value are acceptable because: It is expected to earn more income in future than what the company could get by investing at the required rate of return