Gamehendge Health Center, located in Burlington VT, is considering a purchase of new diagnostic equipment. Wilson, the CEO of Gamehendge, asks you to evaluate the purchase and recommend how to proceed. The equipment costs $800,000 and is expected to be used 15 times a day. Gamehendge is open 300 days per year. On average, each procedure is expected to generate $115 in collections, after contractual allowances, in its first year of use. Thus, net revenues for Year 1 are estimated at 15 X 300 X $100 = $450,000. Incremental labor and maintenance costs are expected to be $150,000 each year of operation, while utilities will add another $10,000 to the Health Center’s utility expense. Both labor/maintenance and utilities are subject to 5% inflation. Incremental Cash overhead is $5000 in Year 1 and will increase by an additional $5000 each year thereafter. The cost of expendable supplies is expected to average $5 per procedure during the first year and is subject to 5% inflation. All revenues, are expected to increase at a 5% inflation rate after the first year. Gamehendge is a for-profit organization.
Wilson, fearing his imminent demise [MKH1] lest he improves financial performance, asks you to assume a 3 year time horizon. The equipment has an estimated salvage value of $400,000 in year 3. The hospital's tax rate is 40%, and its corporate cost of capital is 10%.
The equipment falls into the MACRS five-year class for tax depreciation and hence is subject to the following depreciation allowances:
Year Allowance
1 0.2
2 0.32
3 0.19
4 0.12
5 0.11
6 0.06
A) Estimate the project's net cash flows over its 3-year time horizon.
B) What is the project's NPV? It’s IRR? (Assume average risk.)
C) The supplier of the equipment offers an option to lease the equipment for $150,000 per year. Assume that the leasing company will not cover labor or maintenance costs. Assume the cost of debt is 8%. Should Gamehendge lease or purchase the equipment? (Show your work and include the NAL in your discussion)
D) What is the NPV of the project if leasing is used instead of buying? Does selecting the leasing option make it more or less likely that you recommend to Wilson to go forward with the project?