Problem:
The Philadelphia Clinic, a for-profit medical facility is planning to spend $45,000 for modernized X-ray equipment. It will replace equipment that has zero book value and no salvage value, although the old equipment would have lasted another 7 years.
The new equipment will save $16,000 in cash operating costs for each of the next 7 years, at which time the clinic will sell it for $8,000. A major overhaul costing $4,000 will occur at the end of the fourth year; the old equipment would require no such overhaul. The entire cost of the overhaul is deductible for taxes in the fourth year. The equipment has a 5-year recovery period. The clinic uses MACRS depreciation for tax purposes.
The minimum desired rate of return after taxes is 12%. The applicable income tax rate is 40%.
Compute the after-tax NPV. Is the new equipment a desirable investment?